Last weekend I listened to a one of the speakers from the 2018 Morningstar Conference. The presentation was from one of my favorite speakers, behavioral economist Daniel Kahneman, winner of the 2002 Nobel Prize in Economics.
Kahneman told the crowd about a period when he was working with a team that prided financial planning for very wealthy people. He stated looking back on his experience, he spent the majority of his time developing what he now calls “regret-proof policies.’”
Kahneman described the primary objective of this investment management strategy as “regret minimization.”
It turns out, according to Kahneman, that most individual investors — even very wealthy people — are extremely loss averse. He found that there is always a limit, in dollars or percentages, of how much money people are will to put at risk.
The question Kahneman asked the group was specifically, “‘How much fortune are you willing to lose?’ Most of the time, that number was around 10%.
Kahneman stated that one of the best investment management strategies available is for individual investors to have two stock and bond market portfolios. One is the risky portfolio and one is a much safer portfolio. His recommendation was that each of the two portfolios are managed separately.
Individual investors would get the investment performance results on each of the portfolios separately.
The purpose of these two investment portfolios would be to make individual investors more comfortable with the amount of risk that they are taking with each portfolio. The idea was to establish a mental and emotional wall between the money that the client wants protected and the money that the client is willing to take risks on.
Kahneman stated that the two portfolios don’t touch each other. The psychological distance between the two allows the individual investor to feel safer.
One of the main ideas that came from this Kahneman talk was that individual investors need to become more aware of the risk levels taken in their stock and bond market investments.
This information got me to thinking. What kind of investment portfolio would you classify your company 401(k) retirement plan account?
Ric Lager
Lager & Company, Inc.
