Is Mental Accounting Always Bad?

[RandomGuyOnInternet]

Bogleheads,

I know I am using mental accounting. I'm struggling to see significant downside. I have the below financial goals.

- Fund my children's education from 2024-2030
- Fund my and my spouses retirement beginning in 2030

My AA for each goal is:

- Education: 60/40 dropping to 50/50 next year
- Retirement: 85/15 (Aggressive due to significant pension beginning in 2030)

I hold funds to cover these goals in the following accounts:

- TSP (retirement, accessible in 2030)
- Roth IRAs (retirement, contributions accessible now, earnings accessible in retirement)
- HSA (retirement, planning to wait until 65)
- Taxable (education, VTSAX)
- 529 Plans (education, Vanguard LifeStrategy Conservative and Moderate Growth)

My mental accounting is that I consider these two separate portfolios (education and retirement) with separate AAs based on timeframe and my desire to take risk.

I think some would argue that I should treat them as one portfolio and go with an overall AA of 75/25 and use the G fund in TSP for the full bond allocation. My issue is that the most of the money in the retirement accounts is not realistically available to me before 2030 without some negative consequences (reduced roth space or penalties) and I'd rather not assume the risk of 75/25 in the 529 plans and taxable since a couple bad years could ensure that I do not meet my education funding goals and would have to go to the retirement accounts early.

What am I missing? In this case, is money really fungible?

Thanks

RandomGuy

[Triple digit golfer]

I don't see a problem with it in this case. If mental accounting gets you to the correct endpoint then I don't see a problem.

My child's 529 is in an age-based fund that gets more conservative as she gets closer to college age, but the rest of my portfolio is 80/20 and I plan on keeping it that way.

I figure if we're in a position to give her more than what's in the 529, we'll do so. If not, then she gets what's in the 529 and our retirement stays at 80/20.

[dbr]

It is not mental accounting to have pots of money that have very different uses at very different times affected by different rules, conditions, and tax treatment.

Mental accounting is the act of treating things that have no objective difference as if there is a meaningful difference.

[Triple digit golfer]

It is not mental accounting to have pots of money that have very different uses at very different times affected by different rules, conditions, and tax treatment.

Mental accounting is the act of treating things that have no objective difference as if there is a meaningful difference.

This is a much better and complete answer than mine.

[Nowizard]

As Taylor has said, "There are many roads to Dublin." The responsibility is for due diligence. What "some" people say, if they are considered logical and respected, is to be considered, added to the diligence that makes the decision on your best "road." There is no certainty other than it is certainly important to have a logical and sustainable process for moving from point A to B. Use of a "bucket" approach is one commonly discussed on the Morningstar site, for example.

Tim

[KlangFool]

OP,

"It depends"

If your portfolio is big enough, it won't matter. If not, keeping them separate would not allow you to achieve both goals at the same time.

Is your portfolio big enough?

KlangFool

[retired@50]

The Boglehead wiki says:

Mental accounting

The tendency for people to put their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account. According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors. For example, people often have a special "money jar" or fund set aside for a vacation or a new home, while still carrying substantial credit card debt.

I don't think treating education and retirement money in different ways qualifies as mental accounting.

Source: https://www.bogleheads.org/wiki/Behavioral_pitfalls

Regards,

[dbr]

To answer the actual question, I would say that mental accounting is not necessarily harmful. A person can indulge in mental accounting and arrive at a good answer or may be assisted in arriving at that answer when a more objective approach doesn't compute or isn't available.

On logical grounds I suppose one might argue that mental accounting is irrational by definition and therefore "bad." Probably it is better to avoid mental accounting whenever it is just as easy and practical to avoid it. Mental accounting can lead to some errors in thinking in worst cases.

[RandomGuyOnInternet]

All

I appreciate all the replies. If I can summarize, it seems like the consensus is that this may or may not be mental accounting, but whatever the conclusion, it is not adversely affecting my ability to reach my goals.

After thinking about it, I’d argue that the separate portfolio approach makes it more likely that I will reach the goals. We have more margin in reaching our retirement goals. The education goal will be closer. Increasing volatility by increasing AA in these accounts to 75/25 likely increases likelihood of falling short before I can access the retirement accounts.

Thanks

RandomGuy

[KlangFool]

All

I appreciate all the replies. If I can summarize, it seems like the consensus is that this may or may not be mental accounting, but whatever the conclusion, it is not adversely affecting my ability to reach my goals.

After thinking about it, I’d argue that the separate portfolio approach makes it more likely that I will reach the goals. We have more margin in reaching our retirement goals. The education goal will be closer. Increasing volatility by increasing AA in these accounts to 75/25 likely increases likelihood of falling short before I can access the retirement accounts.

Thanks

RandomGuy

RandomGuyOnInternet,

If you are interested for us to verify your numbers, tell us your numbers.

"After thinking about it, I’d argue that the separate portfolio approach makes it more likely that I will reach the goals."

I would not be so sure about this. If your combined portfolio is big enough, there is no reason to save for college education at all. For example, if your taxable account's annual dividend/distribution would be big enough to pay for the college education, why do you need an education portfolio?

I do not save for college education at all.

KlangFool

[RandomGuyOnInternet]

Klangfool,

Here are the numbers:

Balances
Retirement Savings - $1.1M (Note: I'll continue to contribute >$30k/yr until 2030 retirement)
529 Plans - $205k (No plan for additional contributions)
Taxable - $60k (Note: I'll add an additional $40k before withdrawals start)

Expenses
Education expenses - $365k across 2024-2030
Retirement expenses - $130k/yr - $86k/yr from pension = $44k/yr from portfolio

RandomGuy

[strummer6969]

Like others mentioned, I'm not sure if that is mental accounting. Mental accounting would be for example if: You win a $10,000 lottery and spend the "free" money which would not have done if you had "earned" it.

Your have buckets that have different timeframes for drawing (and hence different asset allocations). I think that is perfectly rational.

[WoodSpinner]

Bogleheads,

I know I am using mental accounting. I'm struggling to see significant downside. I have the below financial goals.

- Fund my children's education from 2024-2030
- Fund my and my spouses retirement beginning in 2030

My AA for each goal is:

- Education: 60/40 dropping to 50/50 next year
- Retirement: 85/15 (Aggressive due to significant pension beginning in 2030)

I hold funds to cover these goals in the following accounts:

- TSP (retirement, accessible in 2030)
- Roth IRAs (retirement, contributions accessible now, earnings accessible in retirement)
- HSA (retirement, planning to wait until 65)
- Taxable (education, VTSAX)
- 529 Plans (education, Vanguard LifeStrategy Conservative and Moderate Growth)

My mental accounting is that I consider these two separate portfolios (education and retirement) with separate AAs based on timeframe and my desire to take risk.

I think some would argue that I should treat them as one portfolio and go with an overall AA of 75/25 and use the G fund in TSP for the full bond allocation. My issue is that the most of the money in the retirement accounts is not realistically available to me before 2030 without some negative consequences (reduced roth space or penalties) and I'd rather not assume the risk of 75/25 in the 529 plans and taxable since a couple bad years could ensure that I do not meet my education funding goals and would have to go to the retirement accounts early.

What am I missing? In this case, is money really fungible?

Thanks

RandomGuy

I see no problem with treating it as separate portfolios. They have different risk characteristics, purposes, and time goals.

WoodSpinner