Mental accounting is an economic concept established by economist Richard H. Thaler, which contends that individuals classify personal funds differently and therefore are prone to irrational decision-making in their spending and investment behavior. Mental accounting is subject matter in the field of behavioral economics.
Is using an Asset Allocation Mental Accounting?
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Is using an Asset Allocation Mental Accounting?
Has anyone ever asked if using an Asset Allocation is mental accounting? I mean you are obviously obfuscating the actual dollar amount and only seem to view risk in percentage terms instead of in relation to something concrete like the possible loss in dollars. To me it seems like mental accounting, reclassifying things as percentages rather than dollars, but I will grant you it is borderline.
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Re: Is using an Asset Allocation Mental Accounting?
TheTimeLord,TheTimeLord wrote: ↑Sat Jan 19, 2019 12:31 pm Has anyone ever asked if using an Asset Allocation is mental accounting? I mean you are obviously obfuscating the actual dollar amount and only seem to view risk in percentage terms instead of in relation to something concrete like the possible loss in dollars.
Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
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Re: Is using an Asset Allocation Mental Accounting?
If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
Total Portfolio Allocation and Withdrawal (TPAW)
Re: Is using an Asset Allocation Mental Accounting?
I don’t even have a good description of mental accounting. What is a good description?
Re: Is using an Asset Allocation Mental Accounting?
To assess risk tolerance, I consider the number of times total fixed investment covers drawdown. For proforma spreadsheets, I set a minimums for the latter and let asset allocation float. The result is that AA in percentage terms stay anyway within a 5% range.
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Re: Is using an Asset Allocation Mental Accounting?
Which to me makes sense because you use a real dollar amount as a guardrail. As opposed to just saying I am X% this and Y% that.KlangFool wrote: ↑Sat Jan 19, 2019 12:37 pmTheTimeLord,TheTimeLord wrote: ↑Sat Jan 19, 2019 12:31 pm Has anyone ever asked if using an Asset Allocation is mental accounting? I mean you are obviously obfuscating the actual dollar amount and only seem to view risk in percentage terms instead of in relation to something concrete like the possible loss in dollars.
Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
KlangFool
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Re: Is using an Asset Allocation Mental Accounting?
Maybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.Ben Mathew wrote: ↑Sat Jan 19, 2019 12:39 pm If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
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Re: Is using an Asset Allocation Mental Accounting?
Which is quite difference than taking some risk tolerance survey that just gives you the percentages to use.Cyclesafe wrote: ↑Sat Jan 19, 2019 2:12 pm To assess risk tolerance, I consider the number of times total fixed investment covers drawdown. For proforma spreadsheets, I set a minimums for the latter and let asset allocation float. The result is that AA in percentage terms stay anyway within a 5% range.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. |
Run, You Clever Boy! [9085]
Re: Is using an Asset Allocation Mental Accounting?
Thanks for that thought provoking statement. It may have helped to provide a bit of focus on an AA question that has been perplexing me. Don't know why but I never considered setting my fixed income amount to a time frame.KlangFool wrote: ↑Sat Jan 19, 2019 12:37 pmTheTimeLord,TheTimeLord wrote: ↑Sat Jan 19, 2019 12:31 pm Has anyone ever asked if using an Asset Allocation is mental accounting? I mean you are obviously obfuscating the actual dollar amount and only seem to view risk in percentage terms instead of in relation to something concrete like the possible loss in dollars.
Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
KlangFool
At a tad less than 3% on only 80% of our nest egg, we have 20 years of drawdown sitting in fixed income and we are 65 years old.
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Re: Is using an Asset Allocation Mental Accounting?
The customary usage has become Asset Allocation in percentages. Then every other way of thinking of the allocations, such as thinking of your allocations as buckets of various needed amounts, has been labeled mental accounting.
Re: Is using an Asset Allocation Mental Accounting?
all money is fungible but not all investment vehicles are fungible.
stocks and bonds are different securities with different purposes. holding both in any combination is not mental accounting.
stocks and bonds are different securities with different purposes. holding both in any combination is not mental accounting.
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Re: Is using an Asset Allocation Mental Accounting?
I think that makes sense. I also think it is a form of liability matching with safe and risky portfolios.
Maybe not mental accounting but just another way of (mentally) looking at things.
EDIT: Perhaps bgf and I are saying something similar!
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Re: Is using an Asset Allocation Mental Accounting?
As I understand it, mental accounting refers to treating money as not fungible when it is in fact fungible--treating interest and principal differently, for example. I'm not sure I see how to map the AA risk misconceptions into that framework. Treating portfolio risk as separate from other forms of risk would probably qualify as mental accounting. Pensions, home ownership, total wealth (your example), etc. should all play into how much risk you're willing to take with your portfolio. If someone is not fully adjusting for that, I can see how it's a form of mental accounting. The dollar in the "portfolio bucket" is being treated differently from other dollars, and risk is being assessed differently in different buckets. If someone sticks to 60/40 in the portfolio regardless of how much money there is and what's going on elsewhere in their life, I think that could be understood as a form of mental accounting.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pmMaybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.Ben Mathew wrote: ↑Sat Jan 19, 2019 12:39 pm If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
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Re: Is using an Asset Allocation Mental Accounting?
TheTimeLord, I'm not sure where you're going on this. I will say, and have said, that during 2008-2009 I found that I was thinking of the downturn, not as a percentage loss, and not as a dollar loss, but as a loss of years of patient savings and progress toward our goal. The experience was not "my 401(k) is now a 201(k)," it was "my 401(k) total is back to where it was six years ago, six years shot to hell, just shot to hell."
I don't know which way of framing the loss--percentage, number of dollars, or number of years further away from goal--is the "right" way to frame it.
I don't know which way of framing the loss--percentage, number of dollars, or number of years further away from goal--is the "right" way to frame it.
Last edited by nisiprius on Sat Jan 19, 2019 5:12 pm, edited 1 time in total.
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Re: Is using an Asset Allocation Mental Accounting?
Klangfool,Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
Are you loosing returns on the fixed income with 5 years of expense? I do not have as much on fixed income, only 6 months, what scenarios/circumstances are you covering with the 5 years of expense? Do you consider bonds as part of the 5 years of fixed income or is this CDs, treasuries, cash?
I am genuinely interested to hear your reasoning, I do not know your circumstances, sometimes I wonder if I am at risk with only 6 months?
DaVinci
" Simplicity is the ultimate sophistication" Leonardo Da Vinci.
Re: Is using an Asset Allocation Mental Accounting?
I can see where asset allocation might be considered a form of mental accounting. In the sense that you treat some money differently than other money. With asset allocation, you treat some money as safe money "I will take less risk with" (fixed income investments), and some money you treat as "I can take more risk with" (stocks, real estate, etc). Money is fungible, right? Where do you draw the line with mental accounting? I don't see much of a problem with mental accounting as long as one is aware of what they are doing
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Re: Is using an Asset Allocation Mental Accounting?
optimization vs. barbell.Davinci wrote: ↑Sat Jan 19, 2019 5:18 pmKlangfool,Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
Are you loosing returns on the fixed income with 5 years of expense? I do not have as much on fixed income, only 6 months, what scenarios/circumstances are you covering with the 5 years of expense? Do you consider bonds as part of the 5 years of fixed income or is this CDs, treasuries, cash?
I am genuinely interested to hear your reasoning, I do not know your circumstances, sometimes I wonder if I am at risk with only 6 months?
DaVinci
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"
Re: Is using an Asset Allocation Mental Accounting?
Davinci,Davinci wrote: ↑Sat Jan 19, 2019 5:18 pmKlangfool,Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
Are you loosing returns on the fixed income with 5 years of expense? I do not have as much on fixed income, only 6 months, what scenarios/circumstances are you covering with the 5 years of expense? Do you consider bonds as part of the 5 years of fixed income or is this CDs, treasuries, cash?
I am genuinely interested to hear your reasoning, I do not know your circumstances, sometimes I wonder if I am at risk with only 6 months?
DaVinci
1) My portfolio is at 20 years of my expense. My AA is 60/40. So, actually, my portfolio has 8 years expense in fixed income now. I can reach my FI goal in less than 5 years even with 5% nominal return and zero contribution. In summary, I do not care about the return. I can afford this. I am preparing for early retirement.
I have 1 year of expense in the emergency fund too. They are not counted as part of my portfolio.
2) I do not prepare for more than 5 years because it is unnecessary. If the recession lasted 5 years, we will have social unrest. Hence, money is the least of the problem. I kept some gold jewelry for that possibility too.
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Re: Is using an Asset Allocation Mental Accounting?
I'm curious why you don't think it's correct. The risk associated with a 60/40 portfolio is the same regardless of the dollar amount of the assets in it.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pmMaybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.Ben Mathew wrote: ↑Sat Jan 19, 2019 12:39 pm If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
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Re: Is using an Asset Allocation Mental Accounting?
Wikipedia provides a good description of mental accounting. Succinctly, it is described there as "the process whereby people code, categorize and evaluate economic outcomes."
With regard to the OP, I do not understand why a percentage AA should be viewed as somehow more logical than understanding one's holdings in terms of years of one's spending. Certainly the latter can be simplified to the former, but the inverse is true as well. The former is easier to mathematically test, but that does not mean that the latter is illogical.
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Re: Is using an Asset Allocation Mental Accounting?
That's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio. And this absolutely changes with the total dollar amount of one's portfolio. For instance, if I had a $100 million portfolio, I would probably lean toward a more conservative allocation than I have now; I need growth now, but in that instance, I would not.vitaflo wrote: ↑Sat Jan 19, 2019 6:00 pmI'm curious why you don't think it's correct. The risk associated with a 60/40 portfolio is the same regardless of the dollar amount of the assets in it.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pmMaybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.Ben Mathew wrote: ↑Sat Jan 19, 2019 12:39 pm If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
The Sensible Steward
Re: Is using an Asset Allocation Mental Accounting?
Klangfool,Davinci,
1) My portfolio is at 20 years of my expense. My AA is 60/40. So, actually, my portfolio has 8 years expense in fixed income now. I can reach my FI goal in less than 5 years even with 5% nominal return and zero contribution. In summary, I do not care about the return. I can afford this. I am preparing for early retirement.
I have 1 year of expense in the emergency fund too. They are not counted as part of my portfolio.
2) I do not prepare for more than 5 years because it is unnecessary. If the recession lasted 5 years, we will have social unrest. Hence, money is the least of the problem. I kept some gold jewelry for that possibility too.
KlangFool
Thank you very much for sharing your plan and circumstances for others to understand how to adjust as we approach early retirement and FI.
1) Your reasoning makes perfect sense to me! One of the Bogleheads principles is to "Never bear too much or too little risk" and in your case and circumstances since you almost made it, you do not need to take too much risk and can certainly afford it.
2) I can appreciate your 5 years reasoning, working in Megacorp before for 15 years I saw a lot of layoffs and folks struggling to find a job for 1-2 years some longer that were not prepared for this.
3) I left megacorp because of this to a more stable job although there is risk anywhere but I feel I reduced risk of layoff for less pay. For this reason also I like to keep my annual expenses low, I always can control my expenses but continued salary is outside my control.
Best of luck to you, but I do not think you need it as you have an excellent plan!
DaVinci
" Simplicity is the ultimate sophistication" Leonardo Da Vinci.
Re: Is using an Asset Allocation Mental Accounting?
Without speaking for Timelord, I think this phrasing gets us to the heart of the issue.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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Re: Is using an Asset Allocation Mental Accounting?
Because while the percentage loss is the same, the potential loss is not.vitaflo wrote: ↑Sat Jan 19, 2019 6:00 pmI'm curious why you don't think it's correct. The risk associated with a 60/40 portfolio is the same regardless of the dollar amount of the assets in it.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pmMaybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.Ben Mathew wrote: ↑Sat Jan 19, 2019 12:39 pm If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
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Re: Is using an Asset Allocation Mental Accounting?
Yep, losing $4,000 from a $10,000 portfolio is a lot different than losing 10 years of expenses from a 25X portfolio even though both loses are 40%.David Jay wrote: ↑Sat Jan 19, 2019 6:23 pmWithout speaking for Timelord, I think this phrasing gets us to the heart of the issue.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio.
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Re: Is using an Asset Allocation Mental Accounting?
As a behavioral issue, it very much depends on the person doing the accounting, but I thought investors were generally advised to take their absolute dollar amount into account when considering their asset allocation, in which case, I think it usually would not be mental accounting. One related thing I have seen that definitely IS mental accounting is the prominent recommendation to hold a separate "emergency fund." In this you may find people who have an 80/20 stock/bond allocation and a huge emergency fund that if accounted for would mean their stock/bond allocation is really 60/40. This is definite mental accounting.
Re: Is using an Asset Allocation Mental Accounting?
It’s not just the size of the portfolio, it is also the stage of life. I was a 100% Stocks into my mid-50s but as I approached retirement I created a “bond tent” comprising my first 6 years of living expenses, which put me at about 50/50. My AA will drift higher as I spend down my portfolio prior to start of SS.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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Re: Is using an Asset Allocation Mental Accounting?
Both are forms of mental accounting and are subject to behavioral fallacies. Percentages (AA model) makes you treat the percentages as something to optimize against regardless of other attributes and ignores wealth effects on utility curves. Thinking about years leads to sunk cost fallacies.nisiprius wrote: ↑Sat Jan 19, 2019 5:10 pm TheTimeLord, I'm not sure where you're going on this. I will say, and have said, that during 2008-2009 I found that I was thinking of the downturn, not as a percentage loss, and not as a dollar loss, but as a loss of years of patient savings and progress toward our goal. The experience was not "my 401(k) is now a 201(k)," it was "my 401(k) total is back to where it was six years ago, six years shot to hell, just shot to hell."
I don't know which way of framing the loss--percentage, number of dollars, or number of years further away from goal--is the "right" way to frame it.
I am starting to think we just accept our biases poison and AA is as good/bad as any heuristic in order to stay the course
FWIW
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Re: Is using an Asset Allocation Mental Accounting?
Funny, cuz if I had a $100m portfolio I'd be 90% stocks, because $10m in bonds is vastly more than I will ever need to live on so I'm willing and able to take the risk on the other $90m that I'll never spend anyway.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio. And this absolutely changes with the total dollar amount of one's portfolio. For instance, if I had a $100 million portfolio, I would probably lean toward a more conservative allocation than I have now; I need growth now, but in that instance, I would not.vitaflo wrote: ↑Sat Jan 19, 2019 6:00 pmI'm curious why you don't think it's correct. The risk associated with a 60/40 portfolio is the same regardless of the dollar amount of the assets in it.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pmMaybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.Ben Mathew wrote: ↑Sat Jan 19, 2019 12:39 pm If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
Risk is all about the ability, willingness and need to take it. Everyone determines this for themselves. To your point, most investors are concerned with their own risk. I feel like the answers to the risk question are highly personal and situation specific.
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Re: Is using an Asset Allocation Mental Accounting?
You certainly could, but the dollar amount involved certainly changes the equation, doesn't it?vitaflo wrote: ↑Sat Jan 19, 2019 10:18 pmFunny, cuz if I had a $100m portfolio I'd be 90% stocks, because $10m in bonds is vastly more than I will ever need to live on so I'm willing and able to take the risk on the other $90m that I'll never spend anyway.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio. And this absolutely changes with the total dollar amount of one's portfolio. For instance, if I had a $100 million portfolio, I would probably lean toward a more conservative allocation than I have now; I need growth now, but in that instance, I would not.vitaflo wrote: ↑Sat Jan 19, 2019 6:00 pmI'm curious why you don't think it's correct. The risk associated with a 60/40 portfolio is the same regardless of the dollar amount of the assets in it.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pmMaybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.Ben Mathew wrote: ↑Sat Jan 19, 2019 12:39 pm If the AA in percentage terms is not connected to portfolio risk somehow, it would be a cognitive error of some kind. But I don't think it would qualify as "mental accounting" as commonly understood.
You don't seem to think so if you'd have a 90% stock allocation with a $100 million portfolio. I don't know how you could claim to 'need' to take risk in that situation at all unless you have some extraordinarily extravagant 'needs'.
That being said, I've never agreed with the "need" aspect of Larry's recommendation though. If you have the ability and willingness, why not take on risk?
The Sensible Steward
Re: Is using an Asset Allocation Mental Accounting?
Note in my reply I didn't say that I needed to take the risk if I had $100m. I said I was willing and able. I tend to agree with you. To me the Need part is optional. Perhaps I should have used "or" rather than "and".willthrill81 wrote: ↑Sat Jan 19, 2019 10:28 pmYou certainly could, but the dollar amount involved certainly changes the equation, doesn't it?vitaflo wrote: ↑Sat Jan 19, 2019 10:18 pmFunny, cuz if I had a $100m portfolio I'd be 90% stocks, because $10m in bonds is vastly more than I will ever need to live on so I'm willing and able to take the risk on the other $90m that I'll never spend anyway.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio. And this absolutely changes with the total dollar amount of one's portfolio. For instance, if I had a $100 million portfolio, I would probably lean toward a more conservative allocation than I have now; I need growth now, but in that instance, I would not.vitaflo wrote: ↑Sat Jan 19, 2019 6:00 pmI'm curious why you don't think it's correct. The risk associated with a 60/40 portfolio is the same regardless of the dollar amount of the assets in it.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pm
Maybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.
You don't seem to think so if you'd have a 90% stock allocation with a $100 million portfolio. I don't know how you could claim to 'need' to take risk in that situation at all unless you have some extraordinarily extravagant 'needs'.
That being said, I've never agreed with the "need" aspect of Larry's recommendation though. If you have the ability and willingness, why not take on risk?
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Re: Is using an Asset Allocation Mental Accounting?
I have a similar IPS rule for my taxable portfolio. It is intended to bridge me to age 70 1/2, and has a rule that under no circumstances shall the SAFE portion of the portfolio be rebalanced below the FLOOR required to bridge me to that age. The FLOOR was computed using Vanguard's Nest Egg Calculator (100% success probability) based upon projected expenses.KlangFool wrote: ↑Sat Jan 19, 2019 12:37 pmTheTimeLord,TheTimeLord wrote: ↑Sat Jan 19, 2019 12:31 pm Has anyone ever asked if using an Asset Allocation is mental accounting? I mean you are obviously obfuscating the actual dollar amount and only seem to view risk in percentage terms instead of in relation to something concrete like the possible loss in dollars.
Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
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Re: Is using an Asset Allocation Mental Accounting?
I wouldn't call it mental accounting -- more like potential mental numbness. Thinking mostly in terms of percentages to validate your risk tolerance can numb you to the dollar risks involved -- especially as your assets grow and/or your near retirement. We live in the world of dollars not percentages.
Percentages also can fool you e.g. a 20% drop in equities followed by a 20% gain doesn't bring you back to even.
There is value in recapping your investments in allocation percentages but always think of your risk in dollar terms. I have a fairly conservative allocation of about 42/58. I have a decent asset level and when I calculate what a 20% drop in equities does in terms of dollars -- it still shocks me
Another potential numbness is understating the impact of rapid loss of human capital as you near retirement.
Percentages also can fool you e.g. a 20% drop in equities followed by a 20% gain doesn't bring you back to even.
There is value in recapping your investments in allocation percentages but always think of your risk in dollar terms. I have a fairly conservative allocation of about 42/58. I have a decent asset level and when I calculate what a 20% drop in equities does in terms of dollars -- it still shocks me
Another potential numbness is understating the impact of rapid loss of human capital as you near retirement.
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Re: Is using an Asset Allocation Mental Accounting?
I have a similar rule where even if equities drop X% my portfolio would still contain a minimum of Y years of expenses.Call_Me_Op wrote: ↑Sun Jan 20, 2019 6:24 amI have a similar IPS rule for my taxable portfolio. It is intended to bridge me to age 70 1/2, and has a rule that under no circumstances shall the SAFE portion of the portfolio be rebalanced below the FLOOR required to bridge me to that age. The FLOOR was computed using Vanguard's Nest Egg Calculator (100% success probability) based upon projected expenses.KlangFool wrote: ↑Sat Jan 19, 2019 12:37 pmTheTimeLord,TheTimeLord wrote: ↑Sat Jan 19, 2019 12:31 pm Has anyone ever asked if using an Asset Allocation is mental accounting? I mean you are obviously obfuscating the actual dollar amount and only seem to view risk in percentage terms instead of in relation to something concrete like the possible loss in dollars.
Not to me. My AA is both correct in term of percentage and absolute amount. And, in my IPS, I will not rebalance my fixed income below 5 years of expense.
KlangFool
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Run, You Clever Boy! [9085]
Re: Is using an Asset Allocation Mental Accounting?
I always know the approximate change of my portfolio both by percentages and actual dollars. Mental accounting is something I am aware of and occasional find some utility in using mental accounting. I look at dividends a little differently than principal although I know they are really the same thing in terms of spending and portfolio value. It is just easier to spend from dividends than to spend from principal and I have no choice but to have the less than tax efficient dividends in my taxable account if I am to stay properly diversified. My risk has a personal definition and it is low as I have other income streams outside of the portfolio and rarely have to spend what is commonly known as principal.
I do have a total return approach to investing despite having a low withdrawal rate. I could have quit working sooner, but I was enjoying myself. I actually quit working several times to retool for different careers in my younger days. I cut back to part time a few years ago to ease into retirement. Now I am very comfortable in retirement and have no need to compete or impress anyone.
I do have a total return approach to investing despite having a low withdrawal rate. I could have quit working sooner, but I was enjoying myself. I actually quit working several times to retool for different careers in my younger days. I cut back to part time a few years ago to ease into retirement. Now I am very comfortable in retirement and have no need to compete or impress anyone.
Re: Is using an Asset Allocation Mental Accounting?
I'm always baffled by these discussions. So what if asset allocation usage is mental accounting? As long as it prevents one from doing self-harm by chasing phantom maximization, what's the issue? So one is guilty of the dreaded mental accounting bias at the expense of ever elusive maximization? Go to confession, say a few prayers and go in peace.
Investors must face the fact that achieving perfection in the complex adaptive systems of investing, personal finance, and the humans living in them will never occur.
Investors must face the fact that achieving perfection in the complex adaptive systems of investing, personal finance, and the humans living in them will never occur.
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Re: Is using an Asset Allocation Mental Accounting?
The impossiblity of perfection should not be used to encourage foolish decisions.2015 wrote: ↑Sun Jan 20, 2019 12:52 pm I'm always baffled by these discussions. So what if asset allocation usage is mental accounting? As long as it prevents one from doing self-harm by chasing phantom maximization, what's the issue? So one is guilty of the dreaded mental accounting bias at the expense of ever elusive maximization? Go to confession, say a few prayers and go in peace.
Investors must face the fact that achieving perfection in the complex adaptive systems of investing, personal finance, and the humans living in them will never occur.
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Re: Is using an Asset Allocation Mental Accounting?
+12015 wrote: ↑Sun Jan 20, 2019 12:52 pm I'm always baffled by these discussions. So what if asset allocation usage is mental accounting? As long as it prevents one from doing self-harm by chasing phantom maximization, what's the issue? So one is guilty of the dreaded mental accounting bias at the expense of ever elusive maximization? Go to confession, say a few prayers and go in peace.
Investors must face the fact that achieving perfection in the complex adaptive systems of investing, personal finance, and the humans living in them will never occur.
Investing is not a science and should not be treated as such. So much of what we do here is arguing about angels dancing on the head of a pin. And contrary to what many, perhaps most, of the 'models' used here assume, maximization of the future value of one's investments is not the sole or even the primary goal of most investors. Like it or not, human beings are emotional, irrational beings, and trying to deny that in pursuit of acting like a robot does not seem like a fruitful endeavor.
Further, mental accounting is not necessarily sub-optimal or irrational. It also depends on what's being optimized.
The Sensible Steward
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Re: Is using an Asset Allocation Mental Accounting?
Investing is very much a science. It's just that for a long time the focus has been on studying the securities being bought and sold rather than the people who were doing the buying and selling. The fact that humans are emotional and not always rational is what makes it worth studying. If it wasn't for our peculiar behaviors, there would hardly be anything worth observing.willthrill81 wrote: ↑Sun Jan 20, 2019 2:56 pm
Investing is not a science and should not be treated as such.
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Re: Is using an Asset Allocation Mental Accounting?
Then we'll have to agree to disagree.Dialectical Investor wrote: ↑Sun Jan 20, 2019 3:19 pmInvesting is very much a science. It's just that for a long time the focus has been on studying the securities being bought and sold rather than the people who were doing the buying and selling. The fact that humans are emotional and not always rational is what makes it worth studying. If it wasn't for our peculiar behaviors, there would hardly be anything worth observing.willthrill81 wrote: ↑Sun Jan 20, 2019 2:56 pm
Investing is not a science and should not be treated as such.
The Sensible Steward
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Re: Is using an Asset Allocation Mental Accounting?
I'd be fine with that. Though, a quick search of your post history and numerous mentions of Richard Thaler suggests we might not disagree as much as it seems.willthrill81 wrote: ↑Sun Jan 20, 2019 3:23 pmThen we'll have to agree to disagree.Dialectical Investor wrote: ↑Sun Jan 20, 2019 3:19 pmInvesting is very much a science. It's just that for a long time the focus has been on studying the securities being bought and sold rather than the people who were doing the buying and selling. The fact that humans are emotional and not always rational is what makes it worth studying. If it wasn't for our peculiar behaviors, there would hardly be anything worth observing.willthrill81 wrote: ↑Sun Jan 20, 2019 2:56 pm
Investing is not a science and should not be treated as such.
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Re: Is using an Asset Allocation Mental Accounting?
Summarizing both of you - I think - investing is not the science of finance as finance is not a science but rather of psychologyDialectical Investor wrote: ↑Sun Jan 20, 2019 3:29 pmI'd be fine with that. Though, a quick search of your post history and numerous mentions of Richard Thaler suggests we might not disagree as much as it seems.willthrill81 wrote: ↑Sun Jan 20, 2019 3:23 pmThen we'll have to agree to disagree.Dialectical Investor wrote: ↑Sun Jan 20, 2019 3:19 pmInvesting is very much a science. It's just that for a long time the focus has been on studying the securities being bought and sold rather than the people who were doing the buying and selling. The fact that humans are emotional and not always rational is what makes it worth studying. If it wasn't for our peculiar behaviors, there would hardly be anything worth observing.willthrill81 wrote: ↑Sun Jan 20, 2019 2:56 pm
Investing is not a science and should not be treated as such.
I might add though that a lot of Thaler’s and Kahnemann’s work has recently been questioned on the province of the studies were abstractions done in a lab setting (WEIRD ones at although that might not be as much a fatal flaw as other psych work)
Maybe psychology is not a science either than
G.E. Box "All models are wrong, but some are useful."
Re: Is using an Asset Allocation Mental Accounting?
I think it is all mental accounting. No matter how you define it, or what you have written down, it is all a form of mental accounting. It does not really matter if you define AA in terms of percentages, or in terms of dollars. Both are forms of mental accounting. For that matter, in my mind, both are forms of bucket accounting. I've got X dollars, some is used to pay current expenses, some is saved for future expenses, some for known future expenses, some for unknown future expenses, some of my saving for the future is in stocks, some in bonds, some in other things. Mental accounting, and buckets. We all do it no matter what label you want to put on it. That is my opinion.
Retired 2019. So far, so good. I want to wake up every morning. But I want to die in my sleep. Just another conundrum. I think the solution might be afternoon naps ;)
Re: Is using an Asset Allocation Mental Accounting?
This claim is easier to make than to justify.TheTimeLord wrote: ↑Sat Jan 19, 2019 9:37 pmYep, losing $4,000 from a $10,000 portfolio is a lot different than losing 10 years of expenses from a 25X portfolio even though both loses are 40%.David Jay wrote: ↑Sat Jan 19, 2019 6:23 pmWithout speaking for Timelord, I think this phrasing gets us to the heart of the issue.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio.
Perhaps there are better risk measures to use than volatility or maximum expected drawdown. Maybe.
But none of that has anything to do with the cognitive error “mental accounting”.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Is using an Asset Allocation Mental Accounting?
Larry included an example of a couple who watched $13 million shrink down to $3 million when the husband continued with a portfolio rich in tech stocks around year 2000. The couple agreed that they didn't need to have their $13 million grow any more and the wife had even expressed concern at the time.willthrill81 wrote: ↑Sat Jan 19, 2019 10:28 pmYou certainly could, but the dollar amount involved certainly changes the equation, doesn't it?vitaflo wrote: ↑Sat Jan 19, 2019 10:18 pmFunny, cuz if I had a $100m portfolio I'd be 90% stocks, because $10m in bonds is vastly more than I will ever need to live on so I'm willing and able to take the risk on the other $90m that I'll never spend anyway.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio. And this absolutely changes with the total dollar amount of one's portfolio. For instance, if I had a $100 million portfolio, I would probably lean toward a more conservative allocation than I have now; I need growth now, but in that instance, I would not.vitaflo wrote: ↑Sat Jan 19, 2019 6:00 pmI'm curious why you don't think it's correct. The risk associated with a 60/40 portfolio is the same regardless of the dollar amount of the assets in it.TheTimeLord wrote: ↑Sat Jan 19, 2019 3:24 pm
Maybe I am not addressing what you were saying but to me to just say you are for example 60/40 and assume that carries the same risk for a $10,000 portfolio as it does for a $10,000,000 is not correct.
You don't seem to think so if you'd have a 90% stock allocation with a $100 million portfolio. I don't know how you could claim to 'need' to take risk in that situation at all unless you have some extraordinarily extravagant 'needs'.
That being said, I've never agreed with the "need" aspect of Larry's recommendation though. If you have the ability and willingness, why not take on risk?
Larry and Bill Bernstein's recommendation to consider "taking some off the table" encouraged me (retired) to move from 80/20 down to 50/50 over the last few years.
VT 60% / VFSUX 20% / TIPS 20%
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Re: Is using an Asset Allocation Mental Accounting?
I've heard him relate that story. I would argue that the biggest problems there were the wife's lack of willingness to be as aggressive with the investments as the husband wanted and a lack of diversification. The maximum drawdown they would have experienced with something like being 100% in VTSAX in decades would have been a 'mere' 50%, and that was followed by a fairly quick recovery, unlike the 60% loss they experienced in individual tech stocks, many of which went bankrupt and never recovered.pascalwager wrote: ↑Mon Jan 21, 2019 3:29 pmLarry included an example of a couple who watched $13 million shrink down to $3 million when the husband continued with a portfolio rich in tech stocks around year 2000. The couple agreed that they didn't need to have their $13 million grow any more and the wife had even expressed concern at the time.willthrill81 wrote: ↑Sat Jan 19, 2019 10:28 pmYou certainly could, but the dollar amount involved certainly changes the equation, doesn't it?vitaflo wrote: ↑Sat Jan 19, 2019 10:18 pmFunny, cuz if I had a $100m portfolio I'd be 90% stocks, because $10m in bonds is vastly more than I will ever need to live on so I'm willing and able to take the risk on the other $90m that I'll never spend anyway.willthrill81 wrote: ↑Sat Jan 19, 2019 6:11 pmThat's true with regard to the portfolio, but most investors are more concerned about the risk to themselves than the risk to their portfolio. And this absolutely changes with the total dollar amount of one's portfolio. For instance, if I had a $100 million portfolio, I would probably lean toward a more conservative allocation than I have now; I need growth now, but in that instance, I would not.
You don't seem to think so if you'd have a 90% stock allocation with a $100 million portfolio. I don't know how you could claim to 'need' to take risk in that situation at all unless you have some extraordinarily extravagant 'needs'.
That being said, I've never agreed with the "need" aspect of Larry's recommendation though. If you have the ability and willingness, why not take on risk?
Larry and Bill Bernstein's recommendation to consider "taking some off the table" encouraged me (retired) to move from 80/20 down to 50/50 over the last few years.
If someone with a $13 million portfolio wants to be 100% stocks, they certainly can do so, but they'd better be prepared for the volatility pertaining thereto, and they would be well served in keeping their fixed expenses relatively low (i.e. I'd say 2% of their portfolio or lower) so that they can dial their withdrawals back when the market nosedives.
Despite my personal preference for high equity allocations, once we reach FI, I strongly suspect that we'll move enough into fixed income to cover at least a few years of expenses.
The Sensible Steward
Re: Is using an Asset Allocation Mental Accounting?
Asset Allocation does not have to be done in percentages of stocks, bonds, and other asset classes. People tend to use percentage because it simplifies the message they are trying to communicate. I often see people give advice to new investors to set AA. How on earth do they know how to do it? Do they even go through an honest evaluation of their personal finance, risk assessment, and other factors in life in order to set a proper asset allocation? I bet they use a "preset" allocation of 40/60, 60/40, 80/20, or 100/0 and adjust it based on how they feel during market ups and downs.TheTimeLord wrote: ↑Sat Jan 19, 2019 12:31 pm Has anyone ever asked if using an Asset Allocation is mental accounting? I mean you are obviously obfuscating the actual dollar amount and only seem to view risk in percentage terms instead of in relation to something concrete like the possible loss in dollars. To me it seems like mental accounting, reclassifying things as percentages rather than dollars, but I will grant you it is borderline.
Mental accounting is an economic concept established by economist Richard H. Thaler, which contends that individuals classify personal funds differently and therefore are prone to irrational decision-making in their spending and investment behavior. Mental accounting is subject matter in the field of behavioral economics.
A proper asset allocation, in my opinion, has to start with risk assessment:
1) How much money do you need to feed you and your family for 3 to 5 years if you lose your jobs? Put it in "bucket #1" which should contain non-stock asset class.
2) How much money are you willing to invest in order to build your wealth? Put it in "bucket #2". This should be majority of equity during wealth accumulation phase.
3) When you are 3-5 years to reach to your FI / retirement goal, how do you plan to preserve your wealth in the event of market crash? Bucket 2 will then become small buckets depends on your view of risk profile.
4) How much money do you want to build your legacy? If you have way more than you need for a "standard" retirement, i.e. $1M-$5M, you can put it in another bucket for real estate, private equity, direct investments, etc.
An alternate method, of course, is 60/40 set-it-and-forget-it allocation.
Time is the ultimate currency.