Yes! It does work!

NotHarry’s approach to portfolio design is backed up by observations in very elevated places!

Below is an extract from Morningstar’s website, published yesterday.  I have read and highly recommend Daniel Kahneman’s (and his colleague’s)  book ‘Thinking Fast and Slow’.  It will go down in history as a seminal publication and be used in all sorts of university courses in the future. 

I certainly bear in mind his analysis and research now.  But I am very pleased to say that my articles on this web site and my recommended use of multiple portfolios to meet client objectives long pre-date my reading of the Nobel Laureate’s work.  It confused compliance people no end as they like to think that a client with risk score ‘x’ gets portfolio ‘y’, not that people are complex psychological units who want multiple things, sometimes in conflict, and don’t like disappointment.  Here is the article:

‘Finding out how people tick is a vital part of the investment process, Daniel Kahneman, Nobel laureate and author of Thinking, Fast and Slow, told the 30th annual Morningstar Investment Conference in Chicago.

He had this advice for financial advisers hoping to steer clients towards reaching their investment goals: “You need to find out what the client’s dreams are, what their fears are. And when bad things happen, you need to be there to help people stay on course.”

Kahneman, speaking with Morningstar behavioural scientist Sarah Newcomb, said that in in investing, research on behavioural biases can be used for good or evil. In the worst case, these biases could be used to exploit clients. In the best case, they could help a client develop and implement their financial plan and potentially improve their outcome

The first step is to decide what’s in the client’s best interest, Kahneman said. Then the adviser needs to find some way to develop a “regret proof” policy – a policy someone can live with when things go badly. This reduces the chance that a client will capitulate at the wrong time and possibly move to another adviser.

Kahneman described a practice he had developed with colleagues to improve investor outcomes. First, the adviser would try to determine the client’s loss aversion to create a measure of projected regret.

“We try to have people imagine various scenarios. We ask them, at what point do you think you would want to bail out?” There are some differences, Kahneman says, but he has found that even extremely wealthy people are loss-averse.

Two-Part Portolios to Manage Risk

The next step was to run client portfolios in two parts. One portfolio holds the assets the client is willing to risk, and the other is a much more conservative portfolio comprising what the client wants to protect. The portfolios are managed separately and clients get the reports individually.

This is helpful for clients because no matter the market environment, one of the portfolios is likely doing well. Of course, financially, it’s one portfolio, but framing it as two separate accounts helps clients understand and tolerate the risks better, he explained.

Asset allocation, in many ways, is the easy part. Helping clients set reasonable goals and adhere to their plan is the difficult part; it requires having in-depth, sometimes personal conversations with client. One element of the process taking a comprehensive look at the client’s present and desired future outcome.

“Individuals tend to do very poorly guessing what stocks will do. Admitting you don’t know is a very healthy step, but this admission leaves you with a great deal to do,” he said.’