Behavioral Portfolio Theory in Practice

Hard Behavioral Finance Behavioral Portfolio Theory

Maria is a seasoned portfolio manager who has always adhered to traditional portfolio theory, which suggests diversification minimizes risk. Recently, however, Maria has been exploring the implications of behavioral portfolio theory in her investment decisions. In behavioral finance, the theory emphasizes that investors are not solely focused on expected returns and risk but also on constructing portfolios based on their psychological biases and emotional preferences.

Maria is considering adjusting her investment strategy by integrating the insights from behavioral portfolio theory. Specifically, she wants to evaluate how different groups of assets might serve distinct functions in her clients’ mental accounts, leading to a more personalized investment approach.

In this context, which of the following would illustrate a key aspect of behavioral portfolio theory that Maria should consider when constructing a portfolio?

Investors tend to segregate their wealth into multiple mental accounts, often prioritizing gains in certain accounts while tolerating losses in others.

Investors consistently behave rationally and base their decisions solely on expected returns and risk.

Investors are indifferent to the composition of their portfolios as long as the overall expected return meets their required threshold.

Hint

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