Imagine you’re walking down the street, and you happen to find a $100 bill lying on the sidewalk. Ordinarily, you’re a pretty frugal person, and you’ve been trying to save some money to put towards buying a car in the future. Today, however, you take your newfound $100 and put it towards an expensive dinner. You tell yourself that this money isn’t “car money”—this is a one-off, special occasion, so why not treat yourself to a nice evening out? Your mental categorization of the $100 bill as different is an example of mental accounting at work.

Mental accounting is a concept from behavioral economics that describes how individuals categorize, evaluate, and manage money in different mental “accounts” rather than treating all money as fungible (easily interchangeable with something else of the same kind and value). One common distinction is between "happy money" (such as windfalls, birthday money, or bills found on the street) and "unhappy money" (the hard-earned money we use for utilitarian consumption).²³ Mental accounting can lead to irrational financial behaviors, such as overspending, misallocating resources, or making riskier decisions with "found money." Understanding this cognitive bias, and the effect it has on us, can help individuals and organizations make better financial choices by treating money more objectively.

Although commonly associated with finances and budgets, mental accounting can also extend beyond money. People often create mental categories for different aspects of their lives, such as time, effort, and emotional investments, influencing how they make decisions and allocate resources.

Take time management, for instance. Depending on the context and the activity, we often treat time very differently. An individual might willingly spend hours binge-watching a favorite TV series but feel reluctant to spend the same amount of time learning a new skill, even if both activities are forms of personal investment. The same applies to emotional effort. Even if we feel exhausted after a long workday, we might still find the energy to socialize with friends because we categorize work-related exhaustion differently from social exhaustion.

Thanks to mental accounting, we often behave illogically when it comes to money and making financial decisions. Depending on where the money came from and what its intended use is, we treat it differently. 

We tend to think less critically about purchases when we've already set aside money for a specific purpose. This can lead us to overlook our overall financial situation and make decisions based on isolated categories rather than the bigger picture. Additionally, the way financial gains or losses are presented influences our reactions, often leading to irrational spending. We often recklessly spend money we gain unexpectedly because it was never part of our financial plan in the first place. Mistakes like these cause us to engage in irrational spending, sabotaging our efforts to save and derailing the management of household finance. 

Unfortunately, with endless financial temptations around us, mental accounting can fuel the sunk cost fallacy.⁷ This is when we persevere with a behavior longer than we really should in order to make our initial investment “worth it”, despite knowing that there are better alternatives out there. Let’s say you’ve spent $100 on a concert ticket, which you bought several months in advance. On the day of the concert, there ends up being a blizzard, making it very difficult and unpleasant for you to get to the venue—arguably so much so that it outweighs your excitement for the show itself.¹⁰ Do you still drive to the concert?

In this situation, many people would feel compelled to make the trip through the blizzard, because otherwise, it would feel like the $100 spent on a ticket has been “wasted.” In reality, the $100 is a sunk cost: it is spent, and no matter what you do, you will still be out $100. If the costs of getting to the concert venue are greater than the pleasure you will get from seeing the show, then at the end of the day, going will result in a worse outcome than staying home.

This behavior can be explained in terms of mental accounting. If you’ve opened a mental “account” for the concert, after you’ve bought the ticket but before you’ve seen the show, it’s like the account has overdrawn $100. If you were to stay home, you would need to close the account with a negative balance, making you more aware of the loss. By going to the concert, however, you feel like you got what you paid for, and the negative balance has somehow been paid off.⁸

Another example of the sunk cost fallacy in action is gambling. When we win on the slots or in a casino, the ‘house money’ effect takes hold.¹⁹ This is when gamblers view the money they win in a mental account separate from the account they view as their own (existing) money. Because this ‘house money’ is treated differently from their overall wealth, they are more likely to re-play it than keep it. This is all fine if the gambler keeps winning, but more often than not, they will start eating into their actual wealth once they start losing. This can lead to financial ruin in the long term. 
However, there is a positive application of mental accounting. By earmarking money for different purposes in our minds, it can help us to budget and keep track of our spending more efficiently.²⁰ Nowadays, our mobile banking apps even help us to compartmentalize our money for different uses within our accounts. Likewise, once we’ve designated an amount of money to a particular purchase or cause (such as buying a new car or saving for a holiday), we may be less inclined to use it for something else because we’ve already mentally accounted for it elsewhere.

On top of leading us to budget poorly, our habit of mental accounting can be easily taken advantage of by marketing companies. Tricks such as offering “bonus” gifts, or pushing “extras” on top of big purchases, are effective because of the cognitive biases that we succumb to while spending money.

Despite their best efforts to remain rational, investors can sometimes fall victim to mental accounting traps when they view recent gains as disposable ‘house money’.¹⁸ When in possession of this ‘extra’ money, they often engage in more high-risk investment decision-making. This is because they make decisions on each ‘mental account’ separately rather than looking at the bigger picture over a longer period of time. 

Mental accounting can also encourage simultaneous borrowing and saving. One study of US households found that 90% of credit card borrowers also had savings accounts, and that one-third of people carrying credit card debt simultaneously had over a month’s worth of salary as liquid savings.²⁰ Because of our aversion to paying off debt with savings money (and society’s push to have us both save and spend), many people are actually costing themselves more money than they really need to. 

However, mental accounting can also be used as a tool by financial institutions to help people be more financially responsible and make budgets. One study looked at how households across the globe typically allocate resources and found that firms and governments are continually designing products, interventions, and regulations to positively influence household budgeting.²¹ 

There are several reasons that our mental accounting processes lead us to make bad financial decisions. These reasons are all rooted in the fact that we tend not to think of value in absolute terms. Instead, an object’s value is relative to various other factors.²

We give money mental labels

One of the core properties of money is that of fungibility, meaning that it is made up of units that are all interchangeable and indistinguishable from one another. Money is fungible because a dollar is worth the same no matter where it came from or how it is spent. Additionally, money doesn’t come with any labels; the same dollar that you put towards your morning coffee could also be spent on a bus ticket, or put towards a new dress.

In mental accounting, however, we tend to treat money as less fungible than it actually is.² This can be thought of as filing money into different mental “bank accounts” based on where it came from that we apply different rules to. Many studies have shown that people tend to label additional income either as “regular income” or as a “windfall gain.” (The above example about finding $100 randomly is an example of a “windfall.”) What’s more, people are more likely to spend windfall gains than regular income—and are more likely to spend them on luxury goods than essential ones.³ Even though there is nothing different about money received unexpectedly compared to money from any other source, we feel like it’s special, so we feel justified in spending it extravagantly.

Not only do we label money based on how we acquired it, but also based on its intended use. An interesting example of this comes from a study on gift card use. When people receive gift cards for a specific retailer, they tend to use them on items that are highly representative of that retailer. For example, when using a gift card at a Levi’s store, people are more likely to buy a pair of jeans, which Levi’s is famous for, than something like a sweater, which is not specific to Levi’s.⁴ The researchers argue that this is because people have put the gift card into a mental account for that specific store, so they feel compelled to spend it in a way that is congruent with the brand.

Our idea of a “good deal” depends on the situation

It is common knowledge that there are certain venues where one can expect to pay much more for the same product than one would elsewhere. For example, when seeing a movie in the theater, most filmgoers know they will have to pay significantly more for a pack of M&M’s than they would at a convenience store. The same goes for many other venues, such as sporting events, concerts, or amusement parks. Often, the expectation that one will pay exorbitant prices for basic goods has become an accepted part of a broader experience. Yes, a simple hotdog costs $10 when you’re buying it from a vendor during a baseball game, but that’s just how these things always are, and eating while you watch is part of the fun!

Why are we so willing to pay for goods that we know are overpriced? The answer is rooted in the fact that, when we buy something, we don’t just care about the objective value of the thing we’re purchasing. We also care about whether we’re getting a good deal. This concept is known as “transactional utility,” meaning the merits of the transaction itself.¹

Transactional utility can have a major influence on our willingness to pay for something. In one experiment, participants were split into two groups and asked to imagine themselves lying on the beach on a hot day, craving an ice-cold bottle of their favorite beer. (The researchers made sure all participants were regular beer drinkers!) In this scenario, a friend volunteers to go and fetch some beer from the only place nearby that sells it. For one group, the vendor was a “fancy resort hotel;” for the other, it was a “small, run-down grocery store.” The friend asks how much the participant is willing to pay for beer, and says he will only buy it if the beer costs as much or less than the price they give.¹

The two different groups responded with very different numbers: while the median answer for the hotel group was $2.65, the median for the grocery store group was $1.50. (This study was done in 1985, so those figures aren’t as low as they sound.)

This result is especially interesting, considering that in this hypothetical scenario, both groups would end up consuming their beer in the same place: on the beach. Ordinarily, places like “fancy hotel resorts” might be able to justify higher prices by arguing that they provide a luxurious “atmosphere” for their customers—but the participants in this study were still willing to pay a premium, even without being able to enjoy that atmosphere.

The main takeaway from this experiment is that our definition of a “reasonable” price is flexible, depending on the situation. If we were only concerned about objective value, we likely wouldn’t be willing to shell out nearly twice as much to drink the same beer in the same place. But transactional utility, or getting a “good deal,” can alter our judgment.

We perceive gains and losses differently depending on their framing

In a study by Daniel Kahneman and Amos Tversky, two of the most influential figures in behavioral economics, participants were told to imagine they were about to purchase a jacket for $125 and a calculator for $15. The calculator salesman then informs the buyer that the same calculator is on sale for $10 at a different branch of the store, which is a 20 minutes’ drive away. 68% of respondents said that they would be willing to make the drive to save $5 on the calculator.

However, with another group of participants, the question was altered: now, the calculator costs $125, and the jacket $15. The calculator is on sale at the other branch for $120. In this case, only 29% of respondents said they would make the trip. In both scenarios, the amount of money being saved is the same.⁵

These different patterns of behavior are related to framing effects, which Kahneman and Tversky first proposed. Their work, and many others’, has shown that the way an option is phrased can have a major impact on our decision-making.

The scenario described in the calculator study is an example of a “topical frame:” the situation is worded in terms of the price of the calculator.⁵ This causes people to perceive the gain of $5 relative to the base price of the calculator. When the calculator ordinarily sells for $15, getting $5 off seems like a great deal, but $5 off a $125 seems like a much smaller gain.

Another factor that affects how we perceive losses and gains is whether they are integrated or segregated—in other words, whether they happen altogether, or are spread out over separate events. Consider the hypothetical example of Mr. A and Mr. B, who have been given some lottery tickets. Mr. A wins $50 in one lottery and $25 in another, while Mr. B wins $75 from a single ticket. Who do you think is happier?

When participants in a study were asked this question, 56 said Mr. A would be happier, 16 said Mr. B would be happier, and 15 said they would be equally as happy. Even though both men came away with the same amount of money, a large majority of people agreed that two smaller wins would make somebody happier than a single, larger one.

However, the opposite is true for losses. In another hypothetical scenario, Mr. A finds out some mistakes have been made on his tax return, and he owes $100 to the IRS. Later that same day, he receives a separate letter informing him he also owes $50 on his state income tax. Meanwhile, Mr. B receives one letter from the IRS, informing him he owes them $150. Again, the amounts of money are the same; and yet, the majority of study participants said that Mr. A would be more upset by these events.

These examples show that people are generally happiest when gains are segregated and losses are integrated. Even if the outcome is the same, we respond very differently depending on how things are presented. This tendency can be taken advantage of by companies trying to separate us from our money. For instance, when buying something expensive like a new car, salespeople often try to tack on “extras,” such as paint protection and entertainment systems. Because these smaller losses are integrated into the much bigger loss of buying the car itself, we don’t feel like it’s such a big deal and are much more vulnerable to springing for additions we don’t need.¹

In general, mental accounting alters our perception of our finances, and makes it easier for us to overspend. It also makes us susceptible to marketing companies looking to make us spend more.

Mental accounting and marketing tactics

As the beer experiment described above showed us, the perceived transactional utility of an item (in other words, whether it’s a good deal) depends on the context and on our past experience. Participants in that study had learned to expect fancy hotel bars to charge more for beer and so they were prepared to pay more for it. Advertisers often try to capitalize on this by promoting their products as high-end, luxurious options, or by trying to associate them with some special occasion. For example, in the 1980s, the beer brand Michelob was well-known for its slogan, “Weekends are made for Michelob.”¹ The goal is to leave customers feeling like the occasion itself is a good enough excuse to indulge in the product—and also willing to pay a premium for it.

Mental accounting gives us a narrow view of our own finances

When it comes to setting budgets for ourselves, mental accounting can lead us astray by having us think in terms of separate accounts rather than consider our financial situation holistically. For example, one might have a mental “coffee” account, for which we mentally budget a certain amount each week for a daily latte from Starbucks. On the one hand, this mental accounting can save us time and energy: we don’t have to go through a decision-making process every single day and try to calculate whether a latte still fits into our budget. On the other hand, once we’ve set up a mental account for coffee, we stop thinking critically about whether we really need to direct so much money at this purpose, or whether we are paying a reasonable price for it—it just becomes a given.⁶

Filing our money away into different mental accounts also blinds us from seeing that some of our money might be put to better use elsewhere. As an example, people such as servers or baristas, who receive tips at work, may engage in mental accounting when they view their tip money is “free money,” exempt from the rules they would apply to their normal income.⁶ This way of thinking can be a barrier to saving up or paying bills on time.

Separate “accounts” make us feel like things are less costly than they are

Finally, mental accounting contributes to the sunk cost fallacy—the tendency to continue with a behavior for longer than we should because we feel like we need to make our initial investment “worth it.”⁷ For example, let’s say you’ve spent $100 on a concert ticket, which you bought several months in advance. On the day of the concert, there ends up being a blizzard, making it very difficult and unpleasant for you to get to the venue—arguably so much so that it outweighs your excitement for the show itself.¹⁰ Do you still drive to the concert?

In this situation, many people would feel compelled to make the trip through the blizzard, because otherwise, it would feel like the $100 spent on a ticket has been “wasted.” In reality, the $100 is a sunk cost: it is spent, and no matter what you do, you will still be out $100. If the costs of getting to the concert venue are greater than the pleasure you will get from seeing the show, then at the end of the day, going will result in a worse outcome than staying home.

This behavior can be explained in terms of mental accounting. If you’ve opened a mental “account” for the concert, after you’ve bought the ticket but before you’ve seen the show, it’s like the account has overdrawn $100. If you were to stay home, you would need to close the account with a negative balance, making you more aware of the loss. By going to the concert, however, you feel like you got what you paid for, and the negative balance has somehow been paid off.⁸

Mental accounting can distort our perceptions of money and lead us to spend based on intuition rather than reason. Luckily, by making a concerted effort to break these bad financial habits, it is possible to prevent yourself from making these mistakes. The best thing you can do to avoid mental accounting is to be deliberate with your money: think critically about your spending habits, keep a close eye on your budgets, and ask yourself if there is any room for improvement.

Create a household budget

Instead of just keeping mental tabs on how you spend your money, it can be helpful to make an outline of all your expenses, and how much you would ideally spend in each category. There are many online budgeting tools to help with this.

If drawing up a whole budget right away is too daunting, just start by tracking your normal spending for a month; make a note anytime you buy something, as well as when you receive any income. By putting numbers to your financial situation, you might be able to see it in a different light. It might not feel like a big deal to pocket all your tips as “free money,” but when you’re keeping track, you may realize that that cash adds up quicker than you thought it did.¹⁰

Make a plan for unexpected income

Windfall gains often end up being spent on spur-of-the-moment purchases. Tax returns are a good example: even though we know to expect a tax return every year, we never know exactly how much it will be, and therefore can’t specifically budget for it. Then, when we do receive that money, it feels like “extra” cash, and becomes easy to spend all at once.

To avoid this, figure out a strategy for unexpected income, like tax returns, gifts, and bonuses. For instance, one might decide to put half of that tax return money into a savings account and spend half on a treat of some kind.¹⁰

Scarcity mindset

A scarcity mindset is a psychological state where individuals focus intensely on a lack of resources, such as money, time, or opportunities. Research suggests that this type of thinking may have an impact on mental accounting. 

One study examined how a scarcity mindset influences the way people spend money, particularly in relation to mental accounting and hedonic (pleasure-driven) vs. utilitarian (practical) consumption.²³ The researchers conducted an online experiment where participants received money either as a windfall gain (unexpected money) or hard-earned income, and then had to choose between hedonic or utilitarian purchases.

The results showed that people who received windfall money were more likely to spend it on hedonic (pleasurable) products. However, this effect disappeared when individuals had a high scarcity mindset, meaning that when people were more focused on financial scarcity, they did not show a preference for hedonic spending. On the other hand, participants who earned their money through effort tended to spend it on utilitarian (practical) products, and this behavior was not influenced by their scarcity mindset.

In other words, the scarcity mindset has an asymmetric effect on consumer spending habits. If we’ve earned it, thinking about the lack of resources is unlikely to sway our decision to spend it. 

Mental accounting was coined by the economist Richard Thaler and was heavily influenced by the work of Kahneman and Tversky. The three men often collaborated with each other, and produced bodies of work that went on to define behavioral economics as a field.

Before Thaler, Kahneman, and Tversky, standard economic theory was based on the assumption that consumers behave rationally. Thaler criticized this theory for being prescriptive rather than descriptive: it prescribed behaviors that the ideal consumer “should” follow rather than described how real people actually act.¹

In several papers, Thaler detailed how mental accounting errors led people to violate many important rules of economic theory—for example, the principle of fungibility. Regardless of its origin or intended use, Thaler recommended that people treat money as a fungible commodity that has a consistent value.²²

Framing effects and the sunk cost fallacy are other examples of how consumers behave irrationally. Importantly, in line with the work of Kahneman and Tversky, Thaler demonstrated that the errors people make are not random; instead, they are “predictably irrational.” Thaler’s work lead him to win the Nobel Prize in economics in 2017.¹¹

Thaler’s work, alongside Kahneman and Tversky, played a crucial role in challenging traditional economic assumptions and reshaping policies and business strategies. His research laid the foundation for the growing field of behavioral economics, which continues to influence areas like public policy, finance, and marketing. Concepts such as nudging—subtly guiding people toward better decisions without restricting choices—have been widely applied, from automatic retirement savings programs to health interventions that help consumers make better long-term choices.

The way we perceive a product or service is highly influenced by multiple factors, including the payment method or plan. This is part of what’s called consumer hedonics, the study of how we derive pleasure, satisfaction, and emotional gratification from products, services, or experiences. We often experience an immediate ‘pain of paying’ when making purchases, which may undermine our enjoyment of the product. Sometimes that pain is delayed. For instance, imagine you’ve bought an amazing new smart ring (all the rage in 2025!) but soon realize that you need to make several in-app purchases to use it to its full potential. 

Economists Drazen Prelec and George Lowenstein proposed a model called ‘prospective accounting’ which describes the reciprocal interactions between the pleasure of consumption and the pain of paying.¹⁶ They argue that consumption that has already been paid for (such as a yearly up-front subscription) can be enjoyed as if it were ‘free.’ At the same time, the pain associated with the initial payment made prior to consumption is actually buffered or reduced by the thoughts of the benefits that will come from that transaction (such as booking an all-inclusive holiday upfront and thinking only of cocktails by the beach while entering your credit card details). In 1998, when Prelec and Lowenstein first proposed this model, they demonstrated that people would prefer to pay a flat rate fee for unlimited internet access rather than by usage, even if it meant paying more (they clearly saw into the future). 

Prelec and Lowenstein suggest that the perfect scenario is when our payments are tightly linked to consumption (i.e., paying evokes thoughts about the benefits) but consumption is not linked to the purchase (i.e., we don’t think about the money we spent while we’re enjoying our product). Striking this balance, however, is a challenge for marketers coming up with the perfect pricing strategies. 

Research shows that we treat refunded money differently from the money we have in our accounts.¹⁷ Dubbed the ‘refund effect’, consumers are more likely to spend money refunded from product returns than unspent money they already have. This is because consumers psychologically realize the loss of money when purchasing products, and so they already earmarked that money for spending (and not saving). When the money comes back to us, it’s still categorized as spending money. However, don’t be fooled into thinking this is a surefire way to trick your brain into buying more: it only works when we don’t expect to return products at the point of purchase, and before the refunded money gets mixed in with the unspent money in our accounts. 

It’s no surprise that mental accounting also carries over into our interactions with digital products. Games or apps that offer in-app purchases often use some form of virtual currency, such as “gems” or “tokens.” We might irrationally spend more money buying virtual currency than we would if we were directly purchasing something. This is because virtual currency creates a mental separation from “real” money. For example, someone might hesitate to spend $5 on a game but won't think twice about buying 500 gems for the same price, even if those gems have a limited in-game utility.

AI can both amplify and counteract mental accounting tendencies, depending on how it is designed and used. AI-powered budgeting tools, such as Mint, YNAB, and AI-driven banking assistants, can help users manage money more rationally by integrating all financial accounts into a single, real-time view. These tools reduce the mental compartmentalization of money by providing holistic insights into spending and savings. AI can also nudge users toward more optimal decisions by offering reminders or warnings when they overspend in one category while underutilizing another. For entrepreneurs, AI technologies have been found to help optimize their mental accounting practices and make more informed decisions about their working capital management.¹⁵

Conversely, businesses often leverage AI to amplify mental accounting tendencies for marketing strategies and increasing sales. AI-driven dynamic pricing models analyze consumer spending behavior, adjusting prices based on what users perceive as a “good deal” within their mental categories. For example, AI can suggest “special offers” or “discounts” that take advantage of a consumer’s tendency to spend windfall gains more freely.

AI-powered loyalty programs also manipulate mental accounting by creating artificial categories of value. For instance, airlines use AI to personalize reward tiers, making travelers feel compelled to redeem miles in certain ways even when a cash alternative might be more flexible.

While it’s clear that AI can influence human mental accounting, researchers have now started looking at the presence of this cognitive bias in machine learning.¹⁴ One study looked at the extent to which Large Language Models (LLMs) exhibit human-like behavioral biases in economic decision-making across four languages: English, Chinese, Spanish, and French. Using Chat GPT Turbo, the researchers applied zero-shot learning (i.e., the LLMs were not given examples or prior training on tasks) to a series of structured experiments and assessed the model’s responses. In addition to loss aversion and transaction utility, the study looked at temporal mental accounting, the process whereby individuals separate or integrate financial gains and losses over time to maximize psychological satisfaction. 

To explore this phenomenon, the LLMs were asked whether they preferred to receive two financial gains simultaneously or spaced apart, and whether they would prefer to integrate or separate losses like tax payments or fines. Additional tests examined how prior outcomes (gains or losses) influenced subsequent risk-taking behavior, comparing LLM responses with human tendencies observed in previous behavioral studies. 

Overall, the researchers found that LLMs mimic some human biases, but that their economic reasoning is not the same across languages. When it comes to temporal mental accounting, English and Spanish LLMs preferred to separate losses over time, while Chinese and French LLMs preferred to separate gains. This contrasts with human behavior, where both losses and gains are typically segregated to maximize psychological comfort. The findings of this paper demonstrate the important role of training data, linguistic structures, and cultural context in shaping and understanding AI-driven decision-making.

It has long been suspected that paying with a credit card, rather than cash, encourages people to spend more money. This suspicion turns out to be supported by evidence: studies have indeed found that people are more willing to pay if a credit card is used, even if they have to pay a large fee to use the card.¹²

One of the main reasons for this is something called payment decoupling, or the separation of the purchase from the payment. Credit cards decouple payments in multiple ways. For one, they delay the actual payment until sometime much later than the purchase (i.e. whenever the credit card bill is due). Even more importantly, payments made with a credit card are less noticeable to us. These payments feel “separate” because we barely register them when we are making them; in fact, research shows that people have worse memory for purchases made by card than purchases made by cash.⁸

Another reason has to do with the integration of losses. As discussed above, we tend to be less upset by losses if they happen all at once, rather than being spaced out. Credit cards play into this by combining many expenses into a single bill. When we’re out shopping, it is often less painful to pay for something by card because, compared to our total credit card bill, this one charge seems relatively small.⁸

When we buy something that we don’t intend to use right away, mental accounting can make that expense feel smaller than it would otherwise. This is because we tend to think about these purchases as “investments,” rather than normal spending. On top of that, whenever we eventually do consume the product we bought in advance, we feel like it’s “free” because we paid for it so long ago.¹³

One example of this mentality in action comes from a paper written by Thaler and Shafir in 2006. One of the authors opens the paper by talking about how, when he moved into his house, it came with a stove that he needed to get rid of. In the end, he made a deal with the owners of a local cafe, giving them the stove in exchange for a stack of coupons to their shop. Even though the coupons each had a designated worth—$5—and had come at the expense of the stove, the author says that the baked goods and coffee he was able to buy with them felt “free.”

Had the cafe owners simply paid with cash rather than coupons, and the author had paid for his breakfasts in this way, it is doubtful that he would still have felt like he was getting something for free. But because the coupons had been purchased in advance, their cost didn’t seem to be associated with his purchases.

What it is

Mental accounting is our tendency to mentally sort our funds into separate “accounts,” which affects the way we think about our spending. Mental accounting leads us to see money as less fungible than it is and makes us susceptible to biases such as the sunk cost fallacy. The concept was first developed by Richard Thaler.

Why it happens

Mental accounting happens mostly because we perceive the value of objects relative to other reference points, rather than in absolute terms. When we are making decisions, the way our options are framed can also impact our perceptions of them.

Example #1 – Credit cards

Mental accounting makes it easier to spend money by credit card because of a process known as payment decoupling: the payment feels “separate” from the thing we are purchasing, and we register it less. This effect is also due to the fact that credit card bills integrate many costs together, which is less upsetting to us than facing them separately.

Example #2 – Advance purchases

When we buy something in advance, we think of it more as an “investment” than as typical—but when we eventually consume the thing we bought, we still don’t register the cost.

How to avoid it

The best way to avoid mental accounting mistakes is to have a budget and to watch your spending more closely. Having a plan for how to deal with unexpected income can also help to avoid blowing this money on unnecessary items.

Time Is Money: How Mental Accounting May Influence What We Spend Our Time On

This article explores how the idea of mental accounting can also be applied to time management. Just as we label money depending on its source and purposes, we also have a habit of labeling blocks of time and treating them differently. This might hinder our productivity and be detrimental to our wellbeing in the long run.

Financial Planning for Millennials: How to Measure Financial Happiness 

Long berated for wasting their money on avocado toast and lattes, the millennial generation is set to receive the largest intergenerational wealth transfer in history in the next couple of decades. What they do with this inheritance is yet to be seen, but their number one priority is happiness. In this article, we use self-determination theory to explore how this generation can financially plan for happiness and look at some insights from our previous research on the topic in Canada.