Morningstar Magazine - August/September 2018 - 59

comfortable with the amount of risk that they
were taking.
Newcomb: That puts a wall in between the money
you can protect, that's going to keep you safe,
and the money that you'll play with. It's all the same
portfolio, really, but there's a psychological distance
between the two.

Kahneman: This is an issue of framing. By
having what you are willing to put at risk in one
portfolio and what you are trying to protect
in another, this corresponds to the way that people
want to think about their decision-making
and about their outcomes. One of the portfolios
will always be doing better than the market,
either the safe one or the risky one, and that gives
people some sense of accomplishment. But
mainly, it's this idea of reducing the risk to a level
that people are comfortable with. That turns out
not to be a lot, even for very wealthy people. When
you ask them how much of their fortune they
are willing to lose, quite frequently you get
something on the order of 10%, which is certainly
not the optimal value.
Newcomb: What I see in the financial advice

Who gets to be the arbiter of what's
in someone's best interest? Who's nudging
the nudgers?
Sarah Newcomb

possibility of their wanting to change their mind,
which is a bad idea, generally, because then
you sell low and you buy high. There is a balance,
and I think that balance can be found.
Newcomb: So, you use loss aversion to create this
measure of projected regret?

Kahneman: We had people try to imagine various
scenarios, and the question was, at what
point do you think that you would want to bail out?
There are some differences, but it turns out that

even very wealthy people are extremely lossaverse. There is a limit to how much money they
are willing to put seriously at risk.
We ended up with a solution where people
actually have two portfolios. One is a risky portfolio
and one is a much safer portfolio. They decide
on the allocation between them. The portfolios are
managed separately, and people get results
on the two of them separately. That was a way
that we thought we could help people be

industry is sort of an existential crisis, an identity crisis.
With advances in technology and products that
enable people to, with the click of a button, craft an
investment portfolio, a lot of advisors are asking, how
do I create value for my clients? We talk at Morningstar
about the value of behavioral coaching. Similarly,
what you're talking about sounds like something that
a robot, by its very nature, can't do.

Kahneman: People are recognizing that individuals
tend to do very poorly in guessing what the
market will do and in guessing how individual
stocks will do. People who have a great deal
of confidence in their ability to do that remember
past successes, when they made a prediction
and it worked. But by and large, admitting that you
don't know is a very healthy step. I think
it's good for advisors to not claim to know more
than, in fact, they do.

But that still leaves them with a great deal to
do. It leaves them with the task of discussing the
client's real needs and capabilities in terms of
taking risk, and what their prospects for the future
are, what their dreams are. Then, there is a
handholding function, which is very important.

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Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018