Thread: House Money Effect

In behavioral finance, House Money Effect theory explains the tendency of an investor to take higher risk with the profits earned from investing than they would like to take with the salary or wages money.

Eg: If an investor books profit of Rs. 50,000 on an investment then he/she will be reinvesting this money by taking higher than usual risk than he would like to take if the same money was earned from salary income.

This is also referred to as Mental Accounting Bias. This happens because the money earned via investment is considered to be "Separate" money.

Investors get aggressive in the case of Mental Accounting Bias and this may lead to higher risk exposure than the planned risk that investors might be willing to take. This can also result in sub-optimal decisions.

TIP: Money earned from any source is the same money. Investing decisions should be based on a process rather than the source of money.