Typically, financial planners have clients take a risk tolerance questionnaire to determine their appropriate asset allocation. They ask questions such as how the clients behave when markets surge or plummet, and how many years they have until retirement.

Though all of this sounds very logical, the problem is that we are emotional beings rather than logical ones. If we were logical beings, we would see the consistent data of dollar-weighted fund returns lagging the returns of the funds themselves. This shortfall is behavioral and, in part, comes from under- and overestimating our ability to take risk.

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