Behaviorial Finance

Question 1

Four Categories of Behaviorial Finance

Answer 1

1. Heuristic Simplification
2. Self-deception
3. Social Influence
4. Emotion

Question 2

Factors to Overcome behaviors

Answer 2

1. Reflexive: Go with the Gut

2. Reflective: Go with logic and methodology

Question 3

Heuristics …

Answer 3

1. Facilitates problem solving and probablility
2. Framed in Generalizations
   aka Rules of Thumb, Snap Judgments

Question 4

Anchoring

Answer 4

Relying too much on OLD information
ANCHORED to an idea or VALUE of a stock

Exercise: Would you buy the stock if it was a brand new purchase?

Question 5

Attachment Bias

Answer 5

Emotionally ATTACHED to an asset.

        "It's all I have left of my dad..."

Question 6

Endowment Bias

Answer 6

ENDOWING an asset with more value because you own it.
Special, perhaps because it was gifted or inherited.

         I Love Lucy memoribalia left to me by my mom must be valuable by now.

Question 7

Cognitive Dissonance

Answer 7

Challenge of reconciling two opposing ideas or beliefs.
NEWLY acquired information conflicts with an OLD idea.
(Oil is always a safe haven …)

Question 8

Confirmation Bias

Answer 8

Collect evidence that supports ideas while dismissing evidence that does not.

CONFIRMING you are right. (to do or NOT do something)

Question 9

Diversification Errors

Answer 9

Idea that you must DIVERSIFY EVENLY accross all asset classes

         Style Box Mania for plan participants in 401k (put 1% across all avaialble investments) 
         without looking at goals or risk tolerance

Question 10

Fear of Regret

Answer 10

Regret AVERSION causes the tendency to take NO ACTION rather than be wrong.

   => Not selling because an asset might "come back"
   => Not buying because an asset might "go down"

Question 11

Gambler’s Fallacy (aka Monte Carlo Fallacy)

Answer 11

A specific chain of events likely predict a specific event.

NOT TRUE. Past events do not predict future results. This believe create Pavlov’s neurotic dogs.

Question 12

Herd Behavior (aka Jumping on the Bandwagon)

Answer 12

Driver is FOMO (Fear of Missing Out)

Follow the crowd

Question 13

Hindsight Bias (Hindsight is 202, shoulda woulda coulda)

Answer 13

Distortion of Past Events to support a perceived PAST bias

Can breed overconfidence

Question 14

Inappropriate Extrapolation

Answer 14

ESTRAPOLATING Trends to support an idea that a certain series of events will continue

Question 15

Analysis Paralysis

Answer 15

PARALYZED by overthinking a problem to the point of not making a decision

Thereby labeling too complicated to fully ANALYZE an overload of options

Question 16

Loss Aversion & Risk Taking

Answer 16

More time spent avoiding losses than seeking gains. AND / OR don’t want to give up gains, look for SURE THING

Question 17

Prospect Theory (related to Loss Aversion and Risk Taking)

Answer 17

Researchers: Khanerman & Tversky

Losses have a greater negative impact than gains a positive impact.
The STRESS caused by a loss is far greater than the ELATION caused by a gain

Question 18

Mental Accounting

Answer 18

Creation of subjective assignment of use and value of money based on the source.

=> Dividing accounts by “safe” and “speculative” when it’s all under the same portfolio.
=> Gambling winnings are for fun spending (even though you are creating more debt and can’t pay the rent.)

Question 19

Outcome Bias

Answer 19

Desired OUTCOME drives decision, regardless of probablility. Research is left by the wayside.

Question 20

Overconfidence (Self-Attribution Bias)

Answer 20

Overconfidence in one’s ability based on recency success and luck rather than true research.

Driving force behind irrational exuberance.

Even Performance managers struggle with Overconfidence

Question 21

Overreaction

Answer 21

Emotional OVERREACTION toward new market information

Question 22

Over-weighting the recent past (Recency Bias)

Answer 22

Perception that easy to find recent patterns become the basis for investment decisions.

Question 23

Self-Affirmation Bias

Answer 23

When things go well it’s because of good decision making.
When things go wrong it’s everyone elses fault.

Related to overconfidence and similar to confirmation bias.

Question 24

Spotting Trends – that are not there

Answer 24

Spotting patterns to support decisions without research.

Related to Inappropriate extrapolation but the trends don’t exist.

Question 25

Status Quo Bias

Answer 25

Tendency to do nothing when action is required.

No effort to make a decision at all.

Question 26

What is Behavioral Finance?

Answer 26

∎ Study of client and planner attitudes, values, and biases;
∎ Addresses sources of money conflict;
∎ Guides principles of counseling;
∎ Offers general principles of effective communication;
∎ Managing crisis events with severe consequences