Nobel Laureate Kahneman on Loss Aversion and the Role of Financial Advisors
Nobel prize-winning psychologist Daniel Kahneman (author of Thinking, Fast and Slow) spoke at this week’s Morningstar Investment Conference in Chicago.
1. Financial advisors need to understand regret. According to Kahneman, clients need advice “they can live with.” To that end, advisors need to understand investors’ loss aversion. Since “regret minimization and profit maximization are different things,” advisors need to “take a broad view and balance what [clients] are worried about with what they want.” Kahneman added that “the optimal allocation for someone who’s prone to regret and for someone who’s not prone to regret are not the same. And the most profit-maximizing allocation isn’t always the right solution.”
2. Human advisors are still important. Loss aversion and associated regret is one of the reasons why Kahneman still sees an important “hand-holding function” for advisors. This includes encouraging clients to imagine pain or regret. “When bad things happen, you have to be there. [Clients] need to have a sense that there’s someone that they trust and has their interests in mind and who knows what they want.”
You can also watch a short video of the conference day here.