Behavioral Finance Terminology Flashcards
Anchoring
Tendency of investors to become attached to a specific price as the fair value of a holding
Attachment Bias
Holding onto an investment for emotional reasons rather than considering more practical applications for the inheritance
Cognitive Dissonance
The challenge of reconciling two opposing beliefs
Confirmation Bias
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.
Diversification Errors
Investors tend to diversify evenly across whatever options are presented to them
Fear of Regret
Tendency to take no action rather than risk making the wrong one
Gambler’s 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
Tendency for individuals to mimic the actions of a larger group
Hindsight Bias
The 20/20 vision we have when looking at a past event and thinking we understand it, when in reality we may not
Inappropriate Extrapolation
Tendency to look at recent events (or market performance) and assume that those events or conditions will continue indefinitely.
Analysis Paralysis
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.
Loss Aversion and Risk Taking
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).
Prospect Theory
Describes the different ways people evaluate losses and gains. Losses have a much greater negative impact than a commensurate gain will have positive.
Mental Accounting
Entails looking at sums of money differently, depending on their source or the intended use.
Outcome Bias
Tendency to make a decision based on the desired outcome rather than on the probability of that outcome.
Overconfidence
Tendency to place too much emphasis on one’s own abilities. It often works hand in hand with confirmation bias.
Overreaction
Investors emotionally react towards new market information.
Over-Weighting the Recent Past
Investors like patterns, and recent past represents a nice, easy-to-find pattern that can become the basis for an investment decision.
Self-Affirmation Bias
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.
Spotting Trends That Are Not There
Investors seek patterns that help support decisions sometimes without adequate confirming research.
Status Quo Bias
Tendency of investors to do nothing when action is actually called for.
Economic and Resource Approach
Financial planner is the agent of change. The focus is on obtaining and analyzing quantitative data, such as cash flow, assets, and debt.
Classical Economics Approach
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.
Strategic Management Approach
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.
