B F Flashcards
Attachment Bias
Attachment Bias
Holding onto an investment for emotional reasons rather than considering more practical appl
for the inheritance.
Example:
My grandfather left me this stock so I can never sell it.
Cognitice dissonance
Cognitive Dissonance
The challenge of reconciling two opposing beliefs
Example: Remembering the positive part of an experience but forgetting the negative.
Confirmation bias
Confirmation Bias
The natural human tendency to accept any information that confirms our preconceived pa
opinion and to disregard any information that does not support that preconceived notion
Example: An investor hears about a hot stock from an unverified source and is intrigued by the
potential returns that investor might choose to research the stock in order to prove is
touted potential is real.
What ends up happening is that the investor finds all sorts of positives about the inve
(low debt to equity), but glosses over potentially financially disastrous negates (dwinding
market).
Diversification errors
Diversification Errors
Investors tend to diversify evenly across whatever options are presented to them.
Example: Consider the style-box mania where investors feel compelled to own a piece of each box in
order to be diversified. 401 K participants tend to spread their money across whatever
options they have.
Anchoring
The tendency of investors to become attached to a specific price as a fair value of a holding
Heuristics
Heuristics are the experiences and viruses that can facilitate problem-solving and probability judgments
Fear Of regret
The tendency to take no action rather than risk making the wrong one
Gamblers fallacy
An individual erroneously believes that the onset of a certain random event is likely to happen following an event or a series of events
Herd behavior
The tendency for individuals to mimic the actions of a larger group. This can also be described as fear of missing out
Hindsight bias
The 2020 vision we had when looking at a past event and thinking we understand it when in reality we may not
Inappropriate extrapolation
The tendency to look at recent events or market performance and assume that those events or conditions will likely to continue indefinitely
Analysis paralysis
Analysis Paralysis (or Paralysis by Analysis)
This describes an individual/couple overanalyzing a situation and can cause decision making to become
‘paralyzed’, meaning that no solution or course of action is decided upon. A situation may be deemed as
too complicated and a decision is never made, due to the fear that a potentially larger problem may arise.
A person may desire a perfect solution but may fear making a decision that could result in error, while
on the way to a better solution. Equally, a person may hold that a superior solution is a short step away,
and stall in its endless pursuit, with no concept of diminishing returns.
Analysis paralysis is when the fear of either making an error outweighs the potential value of success in
a decision made in a timely manner. This imbalance results in suppressed decision making in an
unconscious effort to preserve existing options. An overload of options can overwhelm the situation and
cause the “paralysis”, rendering one unable to come to a conclusion.
Example: Investing is too complex so I will analyze all the various asset allocation strategies and
create a plan. In the end, the investment plan is never created, and the money is still in
cash.
Loss of version and risk taking
Loss Aversion and Risk Taking
While investors are risk averse when it comes to gains (they do not want to give them up), they are risk
seekers when it comes to losses (they will take big risks to avoid realizing them). Given a choice
between a sure gain and a chance to win more, people usually opt for the sure gain. Investors find losses
roughly twice to two-and-a-half times as painful as gains are pleasurable. To avoid the emotional pain
of loss, investors have a strong tendency to hang on to losers (they treat a loss as not real until it ids
realized). In some cases that may turn out to be a good decision and, in some cases, it may turn out to be
bad. The problem is that the investor, faced with a loss, is largely leaving it now to “chance” and hope
rather than to a sound and rationally informed decision based on a reassessment of the fundamentals.
Emotion has clouded the decision. Compounding the problem is that investor’s view errors of omission
as worse than errors of making a bad decision. As a result, investors are biased toward inaction, and
seriously underweight the cost of missed opportunities (opportunity cOst).
Example: An investor sells a strong-performing winner to lock in gains, without considering whether
the investment remains attractive or whether a more attractive investment option exists. It
turns out that the company is well managed with strong fundamentals, and even after the
sale it continues to perform well. Meanwhile, the investor has held on to another loser, and
used some of the proceeds from the sale of his winner to add to his holding in the loser in
the hopes that even a partial rebound will cover the loss.
Prospect theory
Prospect Theory (similar to Loss Aversion/Risk Taking)
It describes the different ways people evaluate losses and gains. The researchers Kahnerman and
Tversky found that losses have a much greater negative impact than a commensurate gain will have
positive.
Example:
In a traditional way of thinking, the amount of utility gained from receiving $50 should t
equal to a situation in which you gained $100 and then lost $50. The end result is the
same which is most people view a single gain of $50 more favorably.
Mental accounting
This entails looking at sums of money differently depending on their source or intended use
