My Journey as an Investor: Navigating Mental Accounting

For over 25 years, I've been learning about investing, trying to make my money work for me.

Along the way, I've faced numerous challenges and learned invaluable lessons. But one thing that really caught my attention is how our minds can trick us when it comes to money.

Here's what I noticed:

Whenever I decided to rebalance my portfolio, something strange happened in my head. When I withdrew funds that had multiplied over time and reinvested them elsewhere, my perception of those investments changed.

Say I put 1 lac into a fund, and over a decade, it turned into 5 lacs. That's a big success! But then, if I took that 5 lacs out and put it somewhere else, my feelings changed.

When I looked at how this new investment was doing, I felt worried, even if it was the same amount of money as before. Despite both schemes experiencing the same drop in value – from 5 lacs to 4 lacs – I found myself feeling more anxious this time around.

The reason…?

The base amount is now 5 lacs, not 1 lac. In a previous case where the base was 1 lac, the drop from 5 to 4 was a loss in profit. But after changing the scheme, the base is now 5 lacs, and it's now a notional loss of 1 lac.

This strange feeling is what they call "Mental Accounting."

My mind had mentally separated the original 1 lac investment from the subsequent gains or losses, leading me to evaluate each investment in isolation rather than considering the broader context of my entire portfolio.

Realizing this, I learned something important:

I need to think about all my investments as part of one big picture, i.e. the overall portfolio, not just as separate pieces. So now, whenever I make decisions about where to put my money, I try to keep this in mind with a broader perspective.

This shift in mindset has empowered me to make more informed and rational choices. I understand that money's value remains constant, regardless of its source or purpose. By avoiding the traps of mental accounting and treating all my money equally (income, bonus, gift, windfall, refund), I ensure that my financial decisions are not only economically sound but also aligned with my peace of mind.

As I continue on my investment journey, I strive to maintain this holistic approach. With each decision, I aim to grow not only my wealth but also my wisdom about investing!

Happy Investing!

(image courtesy: HikingArtist.com)