The Psychology of Money

What you'll learn

• Your Brain on Money
• Prospect Theory and Loss Aversion
• Anchoring: The Price You Cannot Forget
• Mental Accounting: The Money in Different Pockets
• Confirmation Bias and Overconfidence
• Recency Bias and Survivorship Bias
• For Deeper Reading

Key terms

Prospect Theory

The behavioral economic model developed by Kahneman and Tversky (1979) describing how people evaluate gains and losses relative to a reference point, with losses weighted approximately 2.25 times as heavily as equivalent gains.

Loss aversion

The well-documented psychological tendency for the pain of losses to feel approximately twice as intense as the pleasure of equivalent gains.

Reference point

The baseline (often a purchase price) against which gains and losses are evaluated; a central concept in Prospect Theory.

Endowment effect

The tendency to value something more highly simply because you own it, leading investors to hold losing positions longer than rational analysis would justify.

Anchoring

A cognitive bias where people rely too heavily on an initial reference point (such as a purchase price or all-time high) when making subsequent decisions.

Mental accounting

Thaler's concept describing how people categorize and treat money differently based on its source or intended use, violating economic fungibility.

House money effect

The tendency to take greater risks with money perceived as recent gains ("house money") than with money perceived as principal.

Confirmation bias

The tendency to seek out, interpret, and remember information that confirms existing beliefs while ignoring contradicting evidence.

Overconfidence bias

The tendency to overestimate one's knowledge, abilities, or the precision of one's predictions, especially after initial successes.

Recency bias

The tendency to weight recent events more heavily than older ones when forming expectations about the future.

Survivorship bias

The logical error of focusing on the people or projects that survived a selection process while ignoring those that did not, leading to systematically distorted conclusions.