Don’t Let Overconfidence Define Your Risk Profile

Financial advisers spend a lot of time trying to understand a client’s risk profile. They often employ questionnaires that ask myriad questions to try and pinpoint the time period of an investment, investment knowledge and how one would react in various market scenarios.

The problem with these questionnaires is that they only paint a picture based on current trends.

What do I mean by current trends? In an interview last year with Morgan Housel of the Motley Fool, Israeli Nobel laureate Daniel Kahneman explained this concept. “The decision-making process is basically inferring from recent trends as if they were to continue,” he said. “That seems to be the information that people go on, and so when things have been getting worse for a while, you become pessimistic, and when things have been getting better for a while, you become optimistic, and it’s those feelings that really control the investment, I think.”

This is a behavioral economist’s dream. And while I have many points of contention with the behavioral economists, I think they are spot on with this topic.

 

Read more from MarketWatch here

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