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nism-series-xb-mental-accounting-sunk-cost-fallacy[ INVESTMENT ADVISER (LEVEL 2) ]

How does 'Mental Accounting' (Richard Thaler) lead an investor to make irrational portfolio decisions?

[ A ]By calculating portfolio CAGR using mathematical formulas.
[ B ]By rebalancing asset allocation corridors annually.
[ C ]By treating money differently based on its source or intended purpose (e.g., gambling away an annual corporate bonus on high-risk speculative trades while hoarding salary in low-yield savings accounts), violating the economic principle that money is 100% fungible.[ CORRECT ]
[ D ]By maintaining an emergency cash fund of 6 months' expenses.
Takeaway

Option C is correct: By treating money differently based on its source or intended purpose (e.g., gambling away an annual corporate bonus on high-risk speculative trades while hoarding salary in low-yield savings accounts), violating the economic principle that money is 100% fungible.

Derivation
Classical economics treats every rupee as fungible — a rupee from a bonus and a rupee from a salary are economically identical and should be allocated using the same rational criteria. Mental accounting describes how real investors instead assign money to separate mental 'buckets' based on its source, applying different, often inconsistent risk rules to each. A textbook manifestation is treating a windfall bonus as 'house money' for speculative trades the same person would never risk with regular salary, or refusing to pay down high-interest credit card debt while holding idle cash in a low-yield account — sensible only if the two pools are treated as fundamentally different, which economically they are not.
Why the others fail
A — By calculating portfolio CAGR using mathematical formulas.
Calculating portfolio CAGR is a neutral, objective mathematical exercise; it has no connection to the psychological bucketing behavior mental accounting describes.
B — By rebalancing asset allocation corridors annually.
Annual rebalancing across a defined asset allocation corridor is disciplined, systematic portfolio management, not an example of irrational mental bucketing.
D — By maintaining an emergency cash fund of 6 months' expenses.
Holding a dedicated emergency fund equal to several months of expenses is a sound, deliberate liquidity planning decision, not an irrational mental accounting bias.