According to behavioral portfolio theory, how do investors typically construct their portfolios?

Investors typically construct their portfolios in layers according to behavioral portfolio theory. This theory suggests that individuals tend to categorize their investments into different layers based on their psychological needs and goals. Each layer is aligned with specific objectives, such as safety, income generation, and growth potential.

By creating these layers, investors can manage their risk more effectively and are more likely to feel comfortable with their investments because each layer serves a distinct purpose. For instance, an investor might have a secure layer with low-risk assets aimed at preserving capital, and another layer with higher-risk assets pursuing higher returns. This layered approach reflects the way investors think about risk and reward, contrasting with traditional portfolio construction methods that generally focus on overall risk/return optimization.

This method also aligns with how people psychologically handle investments, as it allows them to separate their financial goals and avoid feeling overwhelmed by the complexity of their entire portfolio. Other options, such as focusing solely on short-term gains or managing portfolios as a single layer, do not adequately encompass the nuances of how investors view their financial objectives or the psychological factors influencing their decisions in the context of behavioral finance.