Autoimmune encephalitis (AE) is an immune-mediated disorder that challenges the conventional distinction between neurology and psychiatry. Increasingly, it has been recognized for its frequent presentation with prominent psychiatric symptoms such as psychosis, mood disorders, and catatonia, which often mimic primary psychiatric illness. Understanding and recognizing this presentation is clinically critical, as early initiation of treatments such as immunotherapy is the single most important predictor of positive long-term outcomes. Also, frequently, there have been misdiagnoses where AE is mistaken for schizophrenia or bipolar disorder, causing delays and essential treatment, which results in patient morbidity. This narrative review will address diagnostic and therapeutic uncertainties by summarizing the clinical spectrum of AE, giving importance to antibody-mediated subtypes such as anti-NMDR and anti-LGI1, and also aiming to synthesize evidence on diagnostic challenges, the warning signs, and their management strategies. A definitive diagnosis relies upon a multidisciplinary approach that includes clinical recognition of “red flags” and also the evidence from EEG, MRI, CSF, and FDG-PET testing. The management generally follows a tiered approach to immunotherapy, beginning with corticosteroid, intravenous immunoglobulin, or plasmapheresis and progressing to second-line agents such as rituximab, especially for refractory or higher-risk cases. The use of immunotherapy leads to a substantial recovery in the majority of patients. Yet follow-up studies show that persistent cognitive deficit and residual psychiatric symptoms are very common. Ultimately, this work emphasizes the need for collaboration between psychiatry and neurology to ensure timely intervention and optimize functional recovery.