Behavioural portfolio design
In this chapter: Mental accounting and goal-bucket portfolios · Default options that nudge toward better behaviour
Behavioural portfolio theory (Shefrin & Statman) acknowledges that investors think in mental buckets — different goals, different risk tolerance per bucket. Designing portfolios as goal-buckets (rather than one efficient-frontier portfolio) leverages this. Each bucket has its own asset allocation matched to time horizon and risk capacity for that goal.
Goal-bucket portfolios: (1) Emergency bucket (3-6 months expenses, in liquid funds), (2) Short-term goals 1-3 years (low-equity hybrid, debt), (3) Medium-term 3-7 years (balanced 50/50), (4) Long-term 7+ years (equity-tilted 70/30+), (5) Legacy (multi-generational, equity-heavy). Each bucket has its own IPS and is rebalanced separately. This satisfies the mental-accounting bias rather than fighting it. Defaults that nudge: SIP auto-enrolment for new salaried employees (some employers do this), opt-out of equity for low-tolerance defaults, automatic step-up on annual income increase.
Practitioner insight: bucket rebalancing differs from total-portfolio rebalancing. Buckets are rebalanced when the asset mix within a bucket drifts >5% from target — not the total portfolio. This preserves goal-specific discipline. Also: gain/loss framing per bucket — rather than showing total portfolio P&L, show progress toward each goal ("you're 65% of the way to retirement target"). This shifts the emotional reference from market returns to life outcomes. Most retail platforms don't do this; sophisticated RIAs do.