Risk Policies

"Why Smart People Make Bad Risk Decisions – And How to Avoid Them"

Even the smartest people make poor risk decisions because our brains focus on each choice individually instead of looking at the bigger picture. In Thinking, Fast and Slow, Daniel Kahneman explains that this “narrow framing” leads to overly cautious or reckless choices, depending on how a situation is presented. For example, someone might avoid an investment with a small chance of loss, even if it offers significant long-term benefits. This type of thinking results in inconsistent and often suboptimal financial, business, and personal decisions.

The key to making better choices is adopting risk policies—predefined rules that guide decisions and remove emotion from the equation. Instead of evaluating each risk separately, broad framing helps people see their choices as part of a larger strategy, reducing fear-driven mistakes. Successful investors use this approach to improve their long-term outcomes. By shifting from emotional, case-by-case decisions to a structured risk policy, anyone can make smarter choices and avoid costly mistakes.

For example, people who always take the highest deductible on insurance or skip extended warranties may face occasional losses but ultimately save money in the long run. Having a consistent risk policy ensures that short-term losses don’t derail a strategy that is almost certainly more profitable over time.