Behavioral Finance Terminology

Question 1

Anchoring

Answer 1

Tendency of investors to become attached to a specific price as the fair value of a holding

Question 2

Attachment Bias

Answer 2

Holding onto an investment for emotional reasons rather than considering more practical applications for the inheritance

Question 3

Cognitive Dissonance

Answer 3

The challenge of reconciling two opposing beliefs

Question 4

Confirmation Bias

Answer 4

The natural human tendency to accept any information that confirms our preconceived position or opinion and to disregard any information that does not support that preconceived notion.

Question 5

Diversification Errors

Answer 5

Investors tend to diversify evenly across whatever options are presented to them

Question 6

Fear of Regret

Answer 6

Tendency to take no action rather than risk making the wrong one

Question 7

Gambler’s Fallacy

Answer 7

An individual erroneously believes that the onset of a certain random event is likely to happen following an event or a series of events

Question 8

Herd Behavior

Answer 8

Tendency for individuals to mimic the actions of a larger group

Question 9

Hindsight Bias

Answer 9

The 20/20 vision we have when looking at a past event and thinking we understand it, when in reality we may not

Question 10

Inappropriate Extrapolation

Answer 10

Tendency to look at recent events (or market performance) and assume that those events or conditions will continue indefinitely.

Question 11

Analysis Paralysis

Answer 11

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.

Question 12

Loss Aversion and Risk Taking

Answer 12

Investors are risk averse when it comes to gains (they do not want to give them up), and risk seekers when it comes to losses (they will take big risks to avoid realizing them).

Question 13

Prospect Theory

Answer 13

Describes the different ways people evaluate losses and gains. Losses have a much greater negative impact than a commensurate gain will have positive.

Question 14

Mental Accounting

Answer 14

Entails looking at sums of money differently, depending on their source or the intended use.

Question 15

Outcome Bias

Answer 15

Tendency to make a decision based on the desired outcome rather than on the probability of that outcome.

Question 16

Overconfidence

Answer 16

Tendency to place too much emphasis on one’s own abilities. It often works hand in hand with confirmation bias.

Question 17

Overreaction

Answer 17

Investors emotionally react towards new market information.

Question 18

Over-Weighting the Recent Past

Answer 18

Investors like patterns, and recent past represents a nice, easy-to-find pattern that can become the basis for an investment decision.

Question 19

Self-Affirmation Bias

Answer 19

The belief that when something goes right, it is because you were smart and made the right decision. If it does not work out, it is someone else’s fault or simply bad luck.

Question 20

Spotting Trends That Are Not There

Answer 20

Investors seek patterns that help support decisions sometimes without adequate confirming research.

Question 21

Status Quo Bias

Answer 21

Tendency of investors to do nothing when action is actually called for.

Question 22

Economic and Resource Approach

Answer 22

Financial planner is the agent of change. The focus is on obtaining and analyzing quantitative data, such as cash flow, assets, and debt.

Question 23

Classical Economics Approach

Answer 23

Clients choose among alternatives based on objectively defined cost-benefit and risk-return tradeoffs. The belief is that increasing financial resources or reducing financial expenditures results in improved financial outcomes.

Question 24

Strategic Management Approach

Answer 24

A client’s goals and values drive the client-planner relationship. Conducting a SWOT analysis is done early in the financial planning process. The financial planner serves as a consultant.

Question 25

Cognitive-Behavioral Approach

Answer 25

Clients’ attitudes, beliefs, and values influence their behavior. Planners using this approach attempt to substitute negative beliefs that lead to poor financial decisions with positive attitudes, which should result in better financial results.

Question 26

Endowment Bias

Answer 26

Valuing an asset more when you own it than when you don’t.

Question 27

Framing Bias

Answer 27

You answer/solve a question based on how it was presented to you.

Question 28

Conservatism Bias

Answer 28

Maintaining your previous views by NOT including new contradicting information.

Question 29

Illusion Control Bias

Answer 29

Thinking you can control/affect an outcome when you cannot.

Question 30

Self-Control Bias

Answer 30

Opting for short-term satisfaction over long-term goals.

Question 31

Representative Bias

Answer 31

Urge to categorize new information based on previous experiences.