House Money Effect: Why “Bonus” Cash Changes How We Spend
Ever dreamt of a surprise inheritance or finding an abandoned bag of cash? You might not realize that unexpected money has a strange effect, casting a “spell” on your decisions. Breaking free from it means learning to treat every dollar as truly your own.
Imagine an unexpected $50,000 inheritance from a cousin in Kansas you didn’t even know existed. What would you do with it?
If a coin lands on heads for 10 consecutive flips, the likelihood of heads on the next flip is still just 50%. The streak is nothing more than chance.
Sure, it seems wise to invest it in real estate or save for the future. But more likely, you’ll be tempted to indulge in things like a new car, luxury gadgets, or an extravagant vacation you wouldn’t normally consider.
Or maybe you were already saving a portion of your income for specific goals. Suddenly, though, this random windfall makes you want to spend it on something purely for fun. Your priorities are the same, yet this new amount subtly alters your plans
This principle holds true for profits made on crypto market trades as well.
Suppose you manage to turn $1,000 into $3,000 in no time. Suddenly, that extra $2,000 might start feeling like “house money.” Losing it wouldn’t seem like a big deal (since it’s “just profit,” not truly “your cash”). But, if you win again, the potential return is even greater—after all, $2,000 has more earning power than your starting $1,000.
This kind of mindset is what’s known as the “House Money Effect.”
This cognitive bias causes people to treat “surprise” money with less caution, often spending it more freely than money they’ve worked for. It feels like a bonus or a lottery win, making it easier to justify riskier, more spontaneous choices (thinking it’s not a real loss if it disappears, and another shot might never come).
The bigger the pool of “house money,” the more risks one tends to take. Source: GN Crypto
Here’s a closer look at the “House Money Effect,” its role in investment decisions, what sets it apart from other cognitive traps, and how you can mitigate its influence on your financial planning.
Understanding the House Money Effect
The House Money Effect describes a phenomenon where investors become far more comfortable taking on risks when managing money that isn’t their own hard-earned savings. Instead, they view this “extra” cash more as a “windfall,” leading to less calculated spending.
This effect is often fueled by the perception that such profits aren’t “truly earned,” which lowers the barrier for risk-taking. Subconsciously, many may even feel an urge to part with the funds quickly, aiming to lift an unspoken “burden” from themselves—even if it leads to loss.
With the House Money Effect in play, investors are prone to overlook sound financial judgment and lean toward unplanned expenditures.
The phrase “House Money Effect” was coined in 1990 by economists Richard H. Thaler and Eric J. Johnson of Cornell University’s School of Management.
Their theory was based on studies showing a tendency for people to take greater risks after experiencing financial gains.
Preview of the study “Gambling With the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice.” Source: researchgate.net
For one test group, participants were told they’d “won” $30. They could either take it or flip a coin, where heads meant a cut to $21, and tails meant a boost to $39.
Those in the second group weren’t told they’d “won” anything; they were simply given a choice: accept $30 or flip a coin with the same chances for an increase.
As a result, the first group, seeing the $30 as “house money,” leaned toward taking the gamble, while the second group was more likely to keep the $30.By the end, it was no surprise that more people in the second group still had their cash.
Notably, “House Money Effect” isn’t related to the idea of a house in a traditional sense. It stems from the gambling industry, where casinos are known as “gambling houses.”
Gamblers often treat recently won money as “house money” rather than their own, feeling like they’re playing with someone else’s cash, which encourages taking greater risks.
Illustrating the House Money Effect in a Casino Scenario
Imagine a gambler heads into a casino with $300 he’s prepared to lose. He begins with modest bets on roulette, but soon enough, he’s hit a lucky streak and wins an additional $700, raising his total to $1,000.
At this point, the $700 feels like it’s in a different category from his original cash — it’s “house money.” The House Money Effect kicks in, leading him to increase his risk tolerance.
With this newfound “extra” money, he ditches his careful bets and starts taking bigger risks, ones he wouldn’t normally consider if he was still using just his original cash.
During the losing streak, rather than stepping back, he doubles down, thinking he’s just gambling with “house money.”
As you might expect, he’ll likely walk away with a bigger loss than he intended (although “intending to lose” isn’t usually part of the plan).
Investment Insight: The House Money Effect in Action
Say a beginner to crypto investing puts $5,000 into Bitcoin. Imagine this happened in January 2024, when BTC was $40,000. Ten months later, BTC has gained 65%, handing the investor over $3,000 in profit.
At this juncture, he’s fully feeling the house money effect, mentally segregating the $3,000 profit from his initial capital, labeling it “market cash.”
Believing this extra $3,000 is open for risk, he’s ready to dive in deeper.
Encouraged by this thought process, he invests all the profit in meme coins — an investment he would have otherwise avoided.
If the meme coins don’t deliver, he’ll find himself right back where he began, holding only his initial $5,000.
His choices now are clear: ideally, he’ll recognize the lesson and save his funds, or, at worst, he’ll put his principal at risk, hoping for recovery.
Questioning the Universality of the House Money Effect
Although widely acknowledged, some alternative views question the importance and scope of the house money effect.
These viewpoints focus on investor psychology and suggest different reasons for risk preferences.
House Money Effect Wanes with Time
As investors adjust to gains, the house money effect tends to subside. The early thrill of profits fades, giving way to a steadier approach. Profits start to feel like results of their efforts, not mere luck.
The Effect Lessens as Investment Grows Source: GN Crypto
Thus, as investors achieve greater success, they lean toward calculated investment choices, reducing their willingness to gamble on high risks.
The House Money Effect Has Its Boundaries
As investors’ capital crosses a psychological milestone, their risk tolerance begins to diminish. This benchmark acts as a mental shift, increasing sensitivity to potential losses.
The House Money Effect Wears Off Beyond Capital Level N. Source: GN Crypto
At higher capital levels, the specter of loss looms larger, making investors more mindful of risk. Alongside this, financial stability promotes a focus on preserving gains, causing them to weigh decisions more thoughtfully in terms of asset and strategy choices.
Could the House Money Effect Be an Illusion?
Some critics reject the idea of a House Money Effect, suggesting it’s actually just a reflection of other behaviors.
They argue that risk-taking in investors can be attributed to other factors, such as a natural appetite for risk.
From this angle, the House Money Effect may simply mirror a broader tendency.
For example, individuals may be more open to risk when they have surplus funds—not seeing it as “casino money,” but as a calculated part of their investment plan.
House Money Effect vs Letting Winners Ride
Letting Winners Ride—meaning “letting profits run”—is a strategy where investors let profitable trades continue, aiming for even greater gains instead of cashing out early.
This approach focuses on balancing potential profits with risk.
Practitioners of this approach may take a partial profit after hitting a particular price, leaving the remainder in play to capitalize on sustained market trends.
An example will help illustrate this.
Let’s say a trader bought BTC at $42,197 in January 2024, targeting $51,950, with a stop-loss at $38,540.
If the trader fully closed the position at their target, the RR ratio would be 2.67.
Using the Letting Winners Ride approach, though, they might take profits on half the position at $51,950 while allowing the remaining portion to pursue levels like $58,472 or the previous all-time high of $69,198.
Position strategy with Letting Winners Ride (left shows full lock-in, right shows partial). Source: tradingview.com tradingview.com
This tactic results in an RR of 4.29 — twice what you’d see with a complete close!
The core difference between House Money and Letting Winners Ride is in perception: the former sees profits as “bonus funds,” while the latter considers them personal capital for growth.
The core difference between House Money and Letting Winners Ride is in perception: the former sees profits as “bonus funds,” while the latter considers them personal capital for growth.
House Money Effect vs Gambler’s Fallacy
The Gambler’s Fallacy is a cognitive error where people assume that previous outcomes somehow influence what’s coming next. This belief often appears in gambling settings, like roulette or slots.
Picture this example:
If a coin lands on heads for 10 consecutive flips, the likelihood of heads on the next flip is still just 50%. The streak is nothing more than chance.
A player could reason:
- The next toss is more likely to be tails, thinking, “It’s got to change;”
- Or, they could see heads as more probable, reasoning, “Heads keeps coming up; it must be a pattern.”
Both mindsets result in false expectations and bad bets.
Likewise, in roulette, players may wrongly assume red or black is “due,” and in slots, Free Spins are often expected just because it’s “time.”
The House Money Effect leads players to risk more due to a skewed sense of their funds. With Gambler's Fallacy, misguided bets come from an inaccurate read on chance.
Is it possible to overcome the House Money Effect?
Controlling the House Money Effect, as with any bias, starts with awareness.
Understanding its nature, its origins, and its specific effects on you personally allows you to take practical steps to mitigate its impact.
Steps to Curb the House Money Effect:
- Design clear position management rules. Outline your exit strategy for trades in advance, including price targets, trade size, and points of partial closure.
- Draft a risk management protocol. Consider the relationship between risk and the likelihood of trade setups working out, along with reward-to-risk ratios. Establish daily, weekly, or monthly risk limits and criteria for expanding positions.
- Build a comprehensive trading plan. Include these rules within your trading framework and monitor your mental state during trading sessions, ideal trading times, investment timeline, and financial objectives.
The best shield against the House Money Effect? Discipline.
You need to be clear about what you expect to gain from your investments and on what timeline. With a defined plan, earnings won’t feel like “casino winnings” but will instead fuel your original investment intentions.
At the start, we mentioned everyday scenarios where the House Money Effect often pops up. This bias can appear not only with inheritances but also with lottery winnings, government aid, or even gifts.
Stay alert to the House Money Effect’s sway whenever you sense it affecting your thinking.
