What is a primary effect of mental accounting bias?

Mental accounting bias refers to the tendency of individuals to categorize and treat their money differently based on its source or intended use, often leading to irrational financial decisions. A primary effect of this bias is that investors may disregard the total performance of their overall portfolio and instead focus on specific investments in isolation. This can result in decisions that are not in their best financial interest, such as holding onto losing investments because they do not want to "realize" a loss, while simultaneously being overly eager to spend "gains" from other investments.

By focusing on individual investments rather than considering the overall portfolio and its comprehensive performance, investors may create a disjointed investment strategy that does not align with their long-term financial goals. This mismanagement is a direct consequence of mental accounting bias.

In contrast, diversifying investments across multiple asset classes, evaluating all investments with the same risk tolerance, and combining assets to maximize returns are generally positive investment strategies that are not direct effects of mental accounting bias, but rather ways to potentially mitigate its influence.