CFA Level IPortfolio ManagementMedium
An investor keeps his retirement savings entirely in low-risk bonds, consistent with his stated low overall risk tolerance. Separately, he takes a $10,000 work bonus and invests it aggressively in speculative options, treating it as "house money" unrelated to his core portfolio. This behavior is best described as:
- AAnchoring bias
- BMental accounting
- CConfirmation bias
- DAvailability bias
Show answer & explanationAnswer & explanation
Correct answer: B. Mental accounting
Mental accounting is a behavioral bias in which investors treat money differently depending on its source or intended use, rather than viewing wealth holistically. Here, the investor segregates the bonus into a separate speculative "account" rather than integrating it into his overall risk profile, a classic example of mental accounting.
Why the other options are wrong
- A. Anchoring relates to over-relying on an initial reference point, not compartmentalizing money.
- C. Confirmation bias involves seeking information that supports existing beliefs, not compartmentalizing wealth.
- D. Availability bias involves overweighting easily recalled information, not fund segregation.
Mental Accounting
A cognitive bias in which individuals separate money into distinct mental "buckets" based on source or purpose, rather than treating wealth as fungible.
- Leads to inconsistent risk-taking across accounts
- Common with windfalls treated as 'house money'
- Can cause suboptimal overall portfolio risk management
Memory trick: Money is money — but mental accounting puts it in separate jars.