Risks Is a Four-Letter Word

Evensky, Harold
October 1997
Journal of Financial Planning;Oct97, Vol. 10 Issue 5, p74
Academic Journal
The article provides financial planners with information and insights that will assist with client education of risk concepts. The client's unique psychology forms the psychological structure from which decision-making emanates. Even within this decision-making framework, individuals have very limited ability to process large amounts of information. To manage quantity and complexity of information, the technique employed in decision-making is the use of judgmental heuristics. In a sense, heuristics are analogous to mathematical optimizers in that they may maximize error. A final, interesting twist to mental accounting is the creation of multiple independent accounts. Investors frequently endow their investments with personal characteristics and empower their investment decisions with social commentary. This is a set of blinders investors may wear after making an investment. It assures them that they only will see information confirming their original judgment. Mean variance is the traditional financial model for estimating risk and standard deviation is the most common measure. By understanding the nature of heuristics, a financial planner will be able to better understand the underlying issues influencing a client's risk tolerance.


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