Excellent Piece of Article.
I do agree that time has come to include behavioral finance insight with MPT while constructing clients’s portfolio. The biggest culprits is creation of Clients’s optimal portfolio (risk free Asset + Market Portfolio) considering Investor’s indiffernce curve. However – Investor’s indifference curve is derived out of risk assessment profile – which is faulty (as author has highlighted). Only Behavioral finance can provide insight why a risk averse client – who buys insurance to protect his wealth as well buys a lottery .
My recommendation will be to get rid of risk questionnaire (which is based on template – blame it upon laziness of Institutional approach – one size fits all) and gain insight based on Investor’s past financial decision. It could have been difficult in past – but with recent technology trends / data science fundamentals – It will not be difficult to derive a subjective client specific view based on his past trading decisions (fo obvious reasons, One need to separate his current repetitive decisions, trading decisions, checking / balance accounts, use of mortgages / debts , 401 or IRA account decisions and other factors). This is expected to rationalize true risk assessment of client .
Once again – this was an excellent read and thanks for this insight.