Behavioral Finance Flashcards
Anchoring
Focused on the price you bought something that’s thinking that’s the real value.
Attachment Bias
Holding onto an investment for emotional reasons (grandpa bought it for me, can never sell it)
Herd Behavior
Following the crowd, FOMO, everyone else is doing it, chasing growth stocks.
Gambler’s Fallacy
Believe a series of events should result in a high probability event, even if its random. Stock went up for 10 days, it has to come down, right?
Endowment Bias
- My house is awesome so it’s worth more than it really is.
- Won’t sell a money pit vacation house you own
Heuristics
Experiences, biases, trial and error, rules of thumb, generalizations result in inaccurate decision making.
Cognitive Dissonance
Challenging opposing beliefs
Inappropriate Extrapolation
- Performance has been strong, it should persist
- Economy is doing well, it should keep doing well
- Investment/economy is doing poorly, it will never rebound
- growth stocks have outperformed for 10 years, they should continue
Analysis Paralysis
- Too much information, too complex so don’t make a decision
- Waiting for the perfect information to make the perfect decision, so never make a decision
- Afraid to make a bad decision so keep doing analysis
- Fear of making a bad decision outweighs just making a timely decision
Framing Effect
- Using a narrative to make a decision
- Using positive/negative emotions to make a decision rather than factual data
- A cognitive bias
Confirmation Bais
- Seek out information that confirms one’s belief and ignoring information that doesn’t
- Example: investing in a hot stock that has done well and finding good news for it, but ignore bad facts about it
Diversification Errors
Overly diversifying based on lack of knowledge. Equal weight investments by # of investments in 401k plan, style boxes, etc.
Fear of Regret
Not making a decision because the decision might be wrong. Don’t sell a position because it might go back up and you’d feel worse.
Hindsight Bias
- Hindsight is 20/20. Looking back and figuring out the reason an investment did something and believing you know why.
- Experts come on TV telling why something happened in the past rather than making an investment decision before it happens.
Loss Aversion and Risk Taking
- Would rather lock in a gain even if fundamentals are still solid.
- Don’t want to sell a losing position to “lock in” a loss. A loss isn’t real until it’s sold.
- The error of judgement feels worse than the actual loss, so avoid the error of judgment.
- Often results in inaction (doing nothing), don’t want to lock in a loss.
- Don’t do anything so miss potential opportunities.
