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Mental Accounting and Surplus Optimization

Not related to any exam or mock or anything, but I was just thinking about this - if mental accounting is treating different buckets of money differently, isn’t surplus optimization basically mental accounting since we’re splitting our assets into two buckets - one to match liabilities (safe bucket) and one dedicated for growth (riskier bucket).

So why is mental accounting a bad thing?

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I think the negative aspect of mental accounting is not taking into consideration the correlation of assets within the portfolio (e.g., an investor that do not think her equities portfolio and her treasuries portfolio together). This is relatively different from surplus optimization, right? If you are referring to contingent immunization, for instance, you are taking advantage of a buffer in performance (in that case, the portfolios’ surplus) to increase your alpha, which you couldn’t do should the fund had no surplus.

Three things:

Surplus Optimization is an efficient frontier based on the amount of surplus. This woukd be an mvo style approach . It is different from mental accounting which separates accounts into layers.

Contingent immunization is an investment approach where a fund manager switches to a defensive strategy if the portfolio return drops below a predetermined point. Before that, the whole account is invested for active growth (not just the surplus).

The two portfolio/ hedging portfolio is the one that most resembles mental accounting.