Behaviorial Finance Flashcards
Four Categories of Behaviorial Finance
- Heuristic Simplification
- Self-deception
- Social Influence
- Emotion
Factors to Overcome behaviors
- Reflexive: Go with the Gut
2. Reflective: Go with logic and methodology
Heuristics …
- Facilitates problem solving and probablility
- Framed in Generalizations
aka Rules of Thumb, Snap Judgments
Anchoring
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?
Attachment Bias
Emotionally ATTACHED to an asset.
"It's all I have left of my dad..."
Endowment Bias
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.
Cognitive Dissonance
Challenge of reconciling two opposing ideas or beliefs.
NEWLY acquired information conflicts with an OLD idea.
(Oil is always a safe haven …)
Confirmation Bias
Collect evidence that supports ideas while dismissing evidence that does not.
CONFIRMING you are right. (to do or NOT do something)
Diversification Errors
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
Fear of Regret
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"
Gambler’s Fallacy (aka Monte Carlo Fallacy)
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.
Herd Behavior (aka Jumping on the Bandwagon)
Driver is FOMO (Fear of Missing Out)
Follow the crowd
Hindsight Bias (Hindsight is 202, shoulda woulda coulda)
Distortion of Past Events to support a perceived PAST bias
Can breed overconfidence
Inappropriate Extrapolation
ESTRAPOLATING Trends to support an idea that a certain series of events will continue
Analysis Paralysis
PARALYZED by overthinking a problem to the point of not making a decision
Thereby labeling too complicated to fully ANALYZE an overload of options
Loss Aversion & Risk Taking
More time spent avoiding losses than seeking gains. AND / OR don’t want to give up gains, look for SURE THING
Prospect Theory (related to Loss Aversion and Risk Taking)
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
Mental Accounting
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.)
Outcome Bias
Desired OUTCOME drives decision, regardless of probablility. Research is left by the wayside.
Overconfidence (Self-Attribution Bias)
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
Overreaction
Emotional OVERREACTION toward new market information
Over-weighting the recent past (Recency Bias)
Perception that easy to find recent patterns become the basis for investment decisions.
Self-Affirmation Bias
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.
Spotting Trends – that are not there
Spotting patterns to support decisions without research.
Related to Inappropriate extrapolation but the trends don’t exist.
Status Quo Bias
Tendency to do nothing when action is required.
No effort to make a decision at all.
What is Behavioral Finance?
∎ 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
