Risk Tolerance is Broken: Manage the Psychology of Risk, Don’t Avoid it

The investment industry is in a bind -- we know that risk-intolerant individuals would prefer investments which could actually undermine their long term financial goals. Yet the alternative, assessing the individual's risk capacity and offering fiscally ideal investments, falters if investors drop those "ideal" investments when the going gets tough. Behavioral science offers us a way to support investors' long term goals with ideal investments, while not turning a blind eye to the person's emotions and preferences. The approach is straightforward: stop trying to use asset allocation to avoid risk. Instead, structure the decision-making environment to help empower investors to better handle risk themselves.