Behave

Question 1

Heuristics

Answer 1

• experiences and biases that can facilitate problem-solving and probability judgments.
• generalization or rules of thumb.
• often result in irrational or inaccurate conclusions.

Question 2

Anchoring

Answer 2

The tendency of investors to become attached to a specific price as the fair value of a holding.

Question 3

Attachment Bias

Answer 3

Emotional reasons

Question 4

Cognitive Dissonance

Answer 4

Two opposing beliefs

Question 5

Confirmation Bias

Answer 5

Accepting information in line with beliefs and denying others.

Question 6

Diversification Errors

Answer 6

Diversifying across whatever options are presented.

Investors tend to invest too heavily in shares of the company for which they work.

Question 7

Fear of Regret

Answer 7

No action taken due to risk of making the wrong one.

Question 8

Gambler’s Fallacy

Answer 8

Belief that random events will happen following an event or a series of events.

Another way to think about the gambler’s fallacy: because an event has not happened recently, it has become “overdue” and is more likely to occur.

Question 9

Herd Behavior

Answer 9

individuals mimic actions of a larger group.

Question 10

Hindsight Bias

Answer 10

Believing we understand past events and in reality we may not.

Question 11

Inappropriate Extapolation

Answer 11

assumption that recent events will continue indefinitely.

Question 12

Analysis Paralysis (or Paralysis by Analysis)

Answer 12

• Diminishing Returns.

* No solution or course of action is decided upon.

Question 13

Loss Aversion and Risk Taking

Answer 13

• Opportunity Cost.
• Risk seekers when it comes to losses.

Example: A year ago, you bought shares in Fama Enterprises for $40 per share. Today, these shares are worth $20 each.

If you argued to yourself that if shares in Fama Enterprises were a good buy at $40, then they must be a steal at $20, you probably have a raging case of loss aversion.

Question 14

Prospect Theory

Answer 14

investors are much more distressed by prospective losses than they are happy about prospective gains.

The difference depends on whether the situation is presented in terms of losses or in terms of gains.

phrasing, or framing, of the question causes people to answer the questions differently.

Question 15

Mental Accounting

Answer 15

Looking at money differently, depending on source and intended use.

Think House Money Effect.

Question 16

Outcome Bias

Answer 16

Decision based on desired outcome not probability of that outcome.

Question 17

Overconfidence

Answer 17

• Too much emphasis on one’s abilities.
• Often works hand in hand with confirmation bias.

Another examples of the lack of diversification is investing too heavily in the stocks of local companies.
- Perhaps you know someone personally who works there.
- Perhaps you read about them in your local paper.
Basically, you are unduly confident that you have a high degree of knowledge about local companies.

If you are overconfident about your investment skill, it is likely that you will trade too much.

Question 18

Overreaction

Answer 18

Emotional reaction towards new market information.

Question 19

Over-Weighting the Recent Past

Answer 19

• Little Research.

* Nice, easy to find pattern becomes basis to investment decision.

Question 20

Self-Affirmation Bias

Answer 20

When you are right you were smart. When wrong it was someone else’s fault or just bad luck.

Question 21

Spotting Trends That Are Not There

Answer 21

Following patterns without adequate research.

Question 22

Status Quo Bias

Answer 22

Doing nothing when action is needed.

Question 23

Questions a FINANCIAL PLANNER should ask client to avoid decision errors.

Answer 23

1. ) If due to financial problems you had to sell the investment and then things turned around quickly, would you buy it back?
2. ) Is feeling that you may be wrong affecting your decision?
3. ) What is the client’s risk tolerance?