Behavioral Finance Flashcards
Heuristics
Mental Short-cuts
Biases
Behavioral Biases
- Anchoring
- Attachment Bias
- Endowment Bias
- Confirmation Bias
Financial Infidelity
Lying, keeping secret, accounts, debts, etc
Anchoring
The tendency of investors to become attached to a specific price as the fair value of a holding. The psychological strings of past ownership
Ex: evaluate an investment only as if it were a new purchase. If you would NOT make the purchase now, you should not own it.
If your entire brokerage account were suddenly in cash today, what holdings would you repurchase?
Attachment Effect
Holding onto an investment for emotional reasons rather than considering more practical applications for the inheritance.
Endowment Effect
Value an object at a higher value than FMV. You may not even purchsae the asset now if you didn’t already own it.
Financial Enmeshment
Finances of parents and children are inappropriately comingled
Cognitive Dissonance
The challenge of reconciling two oppossing beliefs
Confirmation Bias
The natural human tendency to accept any information that confirms ouru preconceived position or opinion and to disregard any information that does not support that preconceived notion.
Diversificaiton Erros
Investors will diversify across whatever options are offered to them
Fear of Regret
The tendency to take no action rather than risk making the wrong one.
Gambler’s Fallacy
Belief that the onset of a certain random event is likely to happen following an event or series of events
Herd Behavior
aka FOMO
Tendencey for individuals to mimic actions of a larger group
Hindsight Bias
Thinking we understand a past event, when it reality we may not.
May lead to overconfidence.
Loss Aversion vs. Risk Taking
- GAINS: Investors are risk AVERSE when it comes to gains … they do not want to give them up. Given the choice between a sure gain and a chance to win more, they will pick the sure gain.
- LOSSES: Investors are risk TAKERS when it comes to losses … they will take big risks to avoid realizing them. Investors find losses 2.5 X as painful as gains are pleasurable.
Prospect Theory
- Similar to loss aversion/risk taking
- Describes different ways people evaluate losses and gains
Mental Accounting
Looking at sums of money differently, depending on their source or intended use.
Outcome Bias
Tendency to make a decision based on the desired outcome rather than on the probablity of that outcome.
Overconfidence
Tendency to place too much emphasis on one’s own abilities. Often works hand-in-hand with confirmation bias.
Inappropriate Extrapolation
The tendency to look at recent events and assume that those events or conditions will continue indefinitely.
Analysis Paralysis
Overanalyzing a situation and becoming paralyzed
Overreaction
Investors emotionally react towards new market information
Overweighting the Recent Past
The assumption that the recent past will repeat itself in the future
Self-Affirmation
The belief that when something goes right, it is because you were smart and made the right decision. If it doesn’t work out, it is someone else’s fault or simply bad luck.
Spotting trends that are not there
Investors seek patterns that help support decisions sometiems without adequate confirming research.