Mental Accounting: How Your Brain Categorizes Money
Imagine you're going to see a movie. The ticket costs $10, and you've already bought it. But at the entrance, you discover you've lost the ticket. Would you buy another one? Now consider a different scenario: you're about to buy a ticket when you realize you've lost a $10 bill. Would you still purchase the ticket?
Logically, you're losing the same amount in both cases—$10. But when psychologists Daniel Kahneman and Amos Tversky conducted this experiment in 1984, they discovered a striking difference: only 46% of people agreed to buy a replacement ticket after losing the first one, while 88% were willing to buy a ticket after losing cash. This asymmetry illustrates a phenomenon that economist Richard Thaler named "mental accounting"—a system of internal cognitive operations our brains use to organize, evaluate, and regulate financial decisions.
What is Mental Accounting?
Mental accounting is a behavioral economics concept describing how people categorize money and financial transactions based on subjective criteria: the source of income, intended use, or emotional context. The theory was developed by American economist Richard Thaler, who received the Nobel Prize in Economics in 2017 for his contributions to behavioral economics.
Classical economic theory rests on the principle of fungibility: one dollar always equals another dollar, regardless of where it came from or what it's meant for. However, Thaler's research demonstrated that in real life, people violate this principle constantly—we treat money differently depending on how we've "labeled" it in our minds.
In his foundational paper "Mental Accounting Matters" (1999), published in the Journal of Behavioral Decision Making, Thaler identified three key components of mental accounting:
- Perception and evaluation of outcomes—how we code financial events as gains or losses
- Assignment of activities to accounts—how we distribute money across different "accounts"
- Frequency of account evaluation—how often we assess our financial results
The Movie Ticket Experiment: A Behavioral Economics Classic
Let's return to Kahneman and Tversky's experiment. Why are losing a ticket and losing cash perceived so differently, despite the identical financial outcome?
The answer lies in how our brains categorize expenses. When you bought the ticket for $10, that money was already "debited" from your mental "entertainment" account. If you buy a second ticket, your brain perceives this as spending $20 on a single movie outing—which feels excessive.
But when you lose cash, that money wasn't tied to any specific category. The loss is perceived as a separate event, unconnected to the movie. So purchasing a ticket still "costs" only $10 in your mental bookkeeping.
A recent replication of this study, published in Royal Society Open Science in 2025, confirmed the original findings: 90% of participants agreed to buy a ticket after losing cash, compared to 77% after losing a ticket. The difference remains statistically significant even 40 years after the original experiment.
Three Mental Income Accounts
Research shows that people unconsciously divide their income into three main mental accounts, as described by Thaler and Shefrin in their work "The Behavioral Life-Cycle Hypothesis" (1988):
Current income—money received regularly (salary, monthly payments). People are most willing to spend from this account on everyday needs.
Current assets—savings, investments, bank account balances. People treat these funds more cautiously and spend them less readily.
Future income—anticipated earnings (pension, inheritance, future bonuses). This money is perceived as least accessible for spending.
Research by Abeler and Marklein (2017) confirmed that people violate the fungibility principle even in simple, incentivized experimental settings. Once part of income is assigned to an account, consumers adapt their consumption accordingly.
The Windfall Effect: Why Bonuses Are Spent Differently
Particularly fascinating is how people behave with unexpected income—windfalls. Research shows that money received unexpectedly (bonuses, lottery winnings, tax refunds) is spent very differently from regular income.
According to research by Hodge and Mason (1995), consumers spend a greater portion of their savings when they originated from a windfall gain than from an equivalent amount obtained through work. Studies by Arkes and colleagues found that people tend to spend more when using unexpected gains (such as lottery winnings) compared to anticipated income.
Chambers and Spencer (2008) discovered an interesting pattern: consumers are willing to spend a higher portion of their tax refund when received as a lump sum compared to multiple installments. This is explained by the assignment of lump-sum payments to a "windfall" mental account, while regular payments are perceived as ordinary income.
A 2023 PMC study on mental accounting's influence on consumption decisions revealed that people tend to spend "happy money" (windfalls) on hedonic consumption—things that bring pleasure but aren't necessary. In contrast, "unhappy money" (earned through hard work) is directed toward utilitarian purchases.
Cash vs. Card: How Payment Method Affects Spending
One of the most researched aspects of mental accounting is the difference in spending between cash and card payments. Numerous studies demonstrate that people systematically spend more when paying without cash.
The classic study by Prelec and Simester (2001), published in Marketing Letters, showed that people are willing to pay significantly more for the same items when using cards. An MIT Sloan study (2021) using functional MRI to examine brain activity during purchases revealed the neural mechanisms behind this phenomenon.
According to research by Sachin Banker and Drazen Prelec from MIT Sloan, credit cards activate reward centers in the brain (the striatum)—the same areas involved in addictive substance use. Meanwhile, the influence of price on purchase decisions significantly decreases: costs seem to slip "out of mind."
Federal Reserve data (2024) shows that cash payments account for only 16% of all transactions in the U.S., down from 18% in 2022. The average cash transaction value is $22, compared to $57 for cards. According to Capital One Shopping (2025), consumers spend up to 4 times more when paying by card compared to cash.
A Forbes survey found that 47% of Americans admit that digital wallets make them spend more than when using physical cards or cash. 67% of respondents acknowledged occasionally or constantly losing track of how much they've spent through digital wallets.
Pain of Paying and Why It Matters
The concept of "pain of paying" is central to understanding mental accounting. It's the negative emotional response associated with spending money. A classic example is the unpleasant feeling when watching the fare increase on a taxi meter or at a gas pump.
Research shows that consumers compare the cost of a purchase to the size of the mental account from which funds will be drawn. A $30 t-shirt feels like a bigger expense when paid from $50 in your wallet than from $500 in your checking account.
The larger this proportion, the stronger the "pain of paying" and the lower the likelihood of purchase. Studies also show that people with higher levels of "pain of paying" accumulate less credit card debt.
Cash intensifies the "pain of paying" because it physically leaves your hands. Cards and digital payments reduce this pain by creating psychological distance between the purchase and the spending of money.
The Positive Side of Mental Accounting
While mental accounting can lead to irrational financial decisions, it also has positive applications. Research by Zhang and Sussman (2018) shows that nearly 75% of people who budget use expense categorization as a self-control tool.
A study published in PMC (2023) on the impact of financial literacy, mental budgeting, and self-control on financial wellbeing found that people who practice mental budgeting (categorizing expenses and tracking them) demonstrate higher levels of financial wellbeing.
Research on expense tracking as financial self-regulation (Zhang, 2023) showed that consistent expense tracking is associated with a reduction in the share of discretionary (non-essential) spending. While this doesn't necessarily lead to better adherence to monthly budgets, it helps people better understand their spending habits.
The key insight: when we consciously use money categorization—instead of letting it control us unconsciously—it can become a powerful tool for financial self-regulation.
How Understanding Mental Accounting Can Help
Understanding mental accounting mechanisms allows us to notice our own cognitive biases. Researchers identify several typical situations where mental accounting can lead to suboptimal decisions:
Tax refunds and bonuses. If you tend to spend unexpected income on things you'd never buy with your regular salary, it's worth recognizing: this money has the same value as your regular income.
Segregating debt and savings. Studies show that people may keep money in a low-interest savings account while carrying high-interest credit card debt. Logically, it would make sense to use savings to pay off the debt, but mental accounting prevents "mixing" these accounts.
The "found money" effect. Money received unexpectedly (found, won, given as a gift) is often perceived as "free" and spent less carefully.
Practical Application: The Role of Expense Tracking
Expense tracking tools can harness the natural mechanisms of mental accounting to users' benefit. Research shows that visualizing expenses by category and regularly tracking transactions increases financial awareness.
Expense tracking apps like MyFin allow you to see your financial flows through the lens of categories—which aligns with the natural way our brains organize information about money. Automatic detection of recurring payments helps identify subscriptions and repeated expenses that often "hide" across different mental accounts.
When expenses are visualized and categorized, it becomes easier to notice imbalances between different categories and make conscious decisions about reallocating funds.
Conclusion: Money Is Equal, But Our Perception Isn't
Mental accounting isn't a flaw in human thinking—it's an evolutionary mechanism for simplifying complex financial decisions. In a world where we must make dozens of money decisions daily, categorization helps reduce cognitive load.
However, understanding how mental accounting works allows us to notice situations where our intuitive decisions may be suboptimal. The research of Richard Thaler, Daniel Kahneman, and Amos Tversky has shown that we're all susceptible to these cognitive biases—and recognizing this is the first step toward making more conscious financial decisions.
How do you categorize your financial decisions? Have you noticed that you spend money from different sources differently?
