August 28, 2026 | By the Elystar Team

Imagine you invest ₹10 lakh. Over time, your portfolio grows to ₹15 lakh. You then decide to put ₹2 lakh of those gains into a highly speculative investment.

Now ask yourself a simple question:

Would you have taken the same risk with ₹2 lakh of your original savings? Maybe not.

This is one manifestation of the House Money Effect.

The term comes from research by Richard Thaler and Eric Johnson, who found that prior gains can sometimes increase people's willingness to take subsequent risks. The intuition comes from gambling. After winning, people may begin to feel that they are playing with the “house's money” rather than their own.

Something similar can happen in investing. After a period of strong returns, investors may become more willing to:

• Increase exposure to speculative assets
• Concentrate more heavily in recent winners
• Take risks they previously considered unacceptable
• Rationalize decisions by thinking, “I'm only risking my profits”

But there is a fundamental problem with this reasoning. Once a gain has been earned, it is no longer the market's money. It is your wealth. ₹1 lakh of investment gains has the same economic value as ₹1 lakh of your original capital.

Psychologically, however, investors may not always treat the two in the same way.

Why the House Money Effect Matters in Bull Markets

The effect can become particularly important during prolonged periods of strong market performance. As portfolios rise, investors may gradually become more confident and increasingly willing to take risk. This can happen almost unnoticed.

An investor who originally intended to maintain a diversified portfolio may begin adding speculative positions, increasing concentration in strongly performing assets, or allowing equity exposure to rise well beyond the intended allocation.

The irony is that this greater willingness to take risk may emerge precisely when market optimism and valuations have already increased. In other words, portfolio gains can influence not only how wealthy investors feel, but also how much risk they are willing to accept.

A Disciplined Investment Process Can Help

One way to counter this behavioural tendency is through a disciplined portfolio process.

Rebalancing is particularly useful. When an asset appreciates substantially, periodically bringing the portfolio back toward its intended allocation can prevent market gains from quietly transforming the portfolio's overall risk profile.

For example, if equities rise significantly and become a much larger share of the portfolio than originally intended, rebalancing may involve reducing some of that exposure and reallocating capital elsewhere.

This forces the investor to make decisions based on the portfolio's desired structure rather than on the emotional distinction between “original capital” and “profits.”

More fundamentally, the amount of investment risk an investor takes should be determined by factors such as:

• Financial goals
• Investment horizon
• Ability to withstand losses
• Liquidity requirements
• Overall portfolio construction

—not by whether the money being invested came from the original capital or from recent gains.

The source of the money may feel different. Its economic value is not.
 

Reference: Thaler, R. H. & Johnson, E. J. (1990), Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice, Management Science.
 

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Copyright © 2026 Elystar Investment Management Private Limited. All rights reserved. No part of this publication may be reproduced, distributed, transmitted, published, stored, modified, or used, in whole or in part, without the prior written permission of Elystar Investment Management Private Limited.
 

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