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CPWA 2024 > Applied Behavioral Finance > Flashcards

Applied Behavioral Finance Flashcards

1
Q

Questions to consider in regard to your clients

A

1) Are you adding value to your clients?
2) Are you effectively communicating your wealth to your clients?

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2
Q

Every behavioral framework can be summarized as:

A

Correcting or Moderating cognitive errors
Accommodating emotional biases

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3
Q

Types of Cognitive Errors

A

Belief Perseverance Biases
* Conservatism
* Confirmation
* Representativeness
* Illusion of Control
* Hindsight
Information-Processing Biases
* Anchoring and Adjustment
* Mental Accounting
* Framing
* Availability

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4
Q

Types of Emotional Biases

A
  • Loss Aversion
  • Overconfidence
  • Self Control
  • Status Quo
  • Endowment
  • Regret Aversion
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5
Q

What to consider when deciding to Moderate or Accommodate a client?

A

1) Client’s level of wealth (Fundedness)
2) Nature of client’s behavioral biases

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6
Q

Loss Aversion

A

Feeling twice as bad about a loss as we feel good about an equivalent gain
Preferring to avoid losses over achieving gains

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7
Q

Herding

A

The tendency to conform to group behavior, following the crowd

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8
Q

Recency Effect

A

Overemphasizing recent experiences when making a decision

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9
Q

Availability Bias

A

A cognitive bias where overweighting information that comes most easily to mind or is readily available

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10
Q

Heuristics

A

Cognitive shortcuts or rules of thumb that simplify decision-making

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11
Q

Overconfidence Bias

A

An emotional bias where confidence in one’s own judgment is greater than the objective accuracy of that judgment

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12
Q

Recency Bias

A

A cognitive bias where people are easily influenced by recent news events or experiences
Believe recent events will continue in the future

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13
Q

Confirmation Bias

A

A cognitive bias where there’s a tendency to seek information that reinforces their perception
Seeking information that confirms preexisting beliefs

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14
Q

Familiarity Home Bias

A

Make decisions based on own/familiar experiences

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15
Q

Anchoring/Adjustment Bias

A

A cognitive bias where people have the tendency to focus on specific reference points when making investment decisions

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16
Q

Top Five Client Behavioral Biases

A
  • 35% Recency Bias
  • 26% Loss Aversion
  • 25% Confirmation Bias
  • 23% Familiarity Home Bias
  • 22% Anchoring Bias
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17
Q

Cognitive Biases

A

Biases that involve how people think

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18
Q

Emotional Biases

A

Biases that involve how people feel

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19
Q

Status Quo Bias

A

An emotional bias where people like to maintain things the way they are
Things have always been this way, so they feel comfortable keeping them the same

20
Q

Endowment Bias

A

An emotional bias where people assign a greater value to an investment they already own

21
Q

Hindsight Bias

A

A cognitive bias where people perceive past investment outcomes as if they had been predictable

22
Q

Framing Bias

A

A cognitive bias where people respond to situations differently based on the context in which the choice is presented

23
Q

Cognitive Dissonance Bias

A

A cognitive bias where multiple beliefs intersect and contradict each other. People try to alleviate this discomfort and find ways to rationalize decisions

24
Q

Regret Aversion Bias

A

An emotional bias where people avoid taking decisive actions because they fear that, in hindsight, whatever course they select will prove unwise

25
Q

Conservatism Bias

A

A cognitive bias where people cling to a prior view or forecast at the expense of acknowledging new information

26
Q

Availability Bias

A

A cognitive bias where people estimate the probability of an outcome based on how prevalent that outcome appears to be in their lives

27
Q

Representativeness Bias

A

A cognitive bias that occurs because of a flawed perceptual framework when processing new information
Sometimes, they will project outcomes that resonate with their own preexisting ideas

28
Q

Self-Attribution (Self-Enhancing) Bias

A

A cognitive bias where people have a tendency to ascribe their successes to their own innate talents and to blame failures on outside influences

29
Q

Self-Control Bias

A

An emotional bias which is the tendency to consume today at the expense of saving for tomorrow

30
Q

Affinity Bias

A

An emotional bias which refers to people’s tendency to make irrationally uneconomical decisions based on how they believe a certain product or service will reflect their values

31
Q

Outcome Bias

A

A cognitive bias that occurs when people focus on the outcome of a process rather than on the process used to attain the outcome

32
Q

Illusion of Control Bias

A

A cognitive bias that occurs when people believe that they can control or at least influence investment outcomes when they cannot

33
Q

Biological Processes Involved in Financial Decision Making

A

Amygdala - fight or flight; reptilian part; an intuitive part of the brain
Mammalian part of the brain - creating preferences for different decisions that could be made
Prefrontal cortex - where logical decisions are made and tradeoff decisions are made
Exocortex - handing off complex decisions to outside sources, primarily through technology

34
Q

Intuitive Decision-Making

A

Thought of as decisions that don’t take much effort to come to a conclusion
Very intuitive, instinctual reaction to a choice

35
Q

Deliberative Decision-Making

A

Making a specific choice between options after thought and reason went into it

36
Q

Expected Value Theory

A

The comparison of an anticipated average value/return of one scenario with an anticipated average value/return of another scenario
Determining the weighted averages of potential outcomes to see which one is more favorable

37
Q

Describe Descriptive Utility Function Theory

A

Whether or not people are willing to put the risk on the table to receive a particular gain, even if there’s an infinite expected value
Making decisions based on whether a person is risk averse or not

38
Q

Describe Prescriptive Utility Function Theory

A

A more mathematical model to determine the risk aversion of the average person

39
Q

Describe Mean Variance Model

A

Mathematically create an efficient portfolio for a rational person
Being able to create the most optimal portfolio for a person

40
Q

Describe Prospective Theory

A

Investors value gains and losses differently, placing more weight on perceived losses versus perceived gains

41
Q

Describe Adaptive Market Hypothesis

A

It reconciles Efficient Market Hypothesis (EMH) with research in behavioral economics
Markets evolve over time as individuals different heuristics and biases to make decisions

42
Q

Preserver Investor Personality Type

A

An investor who places a great deal of emphasis on financial security and preserving wealth, rather than taking risks to grow wealth

43
Q

Follower Investor Personality Type

A

An investor who is passive and often lacks interest in and/or has little aptitude for money or investing

44
Q

Independent Investor Personality Type

A

An investor who has original ideas about investing and likes to get involved in the investment process

45
Q

Accumulator Personality Type

A

An investor who is interested in accumulating wealth and is confident that he or she can do so

46
Q

What are the Bailard, Biehl, and Kaiser Investor Models?

A
  1. Individualists – They are confident and careful. Generally do not go to a consultant to manage their investments but do it themselves
  2. Adventurers – Generally go for only big bets. have the resources to do so and willing to take risks. Investments are generally focused and not diversified
  3. Celebrities – Swayed too much by the trend and do not have any expertise or opinion about investments. Approach investment managers frequently
  4. Guardians – Both anxious and careful. Lacking confidence, they approach investment counsels. Generally emphasize safety of the capital while making the investments and a significant proportion of their investments is generally devoted to government securities and guaranteed return investments
  5. Straight arrows – Halfway between complete confidence and anxiety, and extreme carefulness and impetuousness
47
Q

Mental Accounting

A

Treating various sums of money differently based on where these monies are mentally categorized

CPWA 2024 (11 decks)

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