SVLTI Meetup on Goal-Based Investing with Mental Accounts

On February 1, SVLTI (Silicon valley long term investors) conducted a meetup on the topic of goal-based investing with mental accounts. We invited professor Sanjiv Das from Santa Clara University's Leavey School of Business to speak about this very important topic. Professor Das's seminal research with Markowitz and Statman on the topic of portfolio optimization with mental accounts has had great impact on the subject of goal based wealth management.

The key take-away from the meetup was that investment allocations should be based on one's goals. The traditional finance theory talks about risk in terms of variance, but for most investors the risk is not meeting a certain financial goal. There are some goals that are must-have and some that are nice-to-have. For nice-to-have goals one may afford to take more risk, but for must-have goals we cannot afford to take much risk. Thus different goals lend themselves to different required probabilities of success. This gives rise to the idea of defining risk as a probability of not meeting a goal with a certain percentage. So I can have a goal of turning my 1 dollar today to 1.20 in 5 years and I may want to set the probability of not meeting that goal to 0 % or 5 % or even more. As I relax the constraint on the probability number I can afford to put more money in a risky asset, such as equities.

Behavior portfolio theory looks at investors' behavioral tendencies when it comes to investing. Individuals seek both safety and thrill in life. This explains things at both ends of spectrum: buying insurance and buying lottery tickets. Taking this idea to portfolio allocation suggests that we need to create asset allocations in the context of different goals - mental accounts in behavior portfolio theory - investors have. This paradigm seeks to create optimal sub-portfolios for each goal and leads to a division of the assets in different categories: safe very little risk, diversified market risk, undiversified high risk.

To summarize, we had an interesting meetup and we all became wiser in terms of our investing knowledge. In the future, we will continue to invite finance experts to expand our knowledge about the world of investments and finance.