BF+AA R2 Flashcards
Uses and limitations of classifying investors into personality types
Uses:
Portfolio is closer to the efficient frontier
More satisfied clients
Clients stay on track with longer term goals
Better working relationships with advisor/client
Limitations:
Can display emotional and cognitive errors at same time
Can display traits of more than one behavioral investor type
As investors age, they become more emotional and risk averse
Not all investors in the same behavioral type should be treated the same
Individuals act irrationally
How behavioral factors affect advisor-client relationships
Advisor better understands reasons for client goals
Adds structure and professionalism to relationship
Advisor better equiped to meet client needs
Closer bond and happier clients
How behavioral factors influences portfolio construction
1) DC plan clients
2) Owning company stock
3) General investor
DC:
Status Quo Bias - investors make no changes to initial asset allocation
Naice Diversification - 1/n - equally allocated
Company Stock:
Familiarity - underestimate risk/overconfident
Naive Extrapolation - Companies recent good performance is now expected for future performance
Loyalty - Employees hold onto company stock in efforts to help company
Financial incentive - tax/purchase discounts
Other:
Overconfidence - investors trade to often
Disposition Effect - Hold onto losers too long, sell winners too quick
Home bias - too much allocation to local market
Mental accounting - portfolio contructed in layers (to meet individual goals)
How behavioral finance can be applied to the process of portfolio construction
Taget date funds to overcome status quo bias
Layered portfolios accomodate perceptions of risk and importance of staying with goals
Discuss how behavioral factors affect analyst forecasts
Analysts typically exhibit 3 biases:
1) Overconfidence
Illusion of knowledge
Self-attributiom
Representativeness
Availability
Illusion of control
Hingsight
2) Interpreting management reports
Framing
Anchoring and Adjusting
Availability
3) Biases in own Research
Too much data collection
Illusion of control
Gamblers Fallacy
Confirmation Bias
Discuss how behavioral factors affect investment commitee decision making and recommend techniques to mitiage risk
Commitees are subject to individual biases and social-proof (go along with group think)
To mitigate, seek diverse backgrounds and opinions and people who are not afraid to express opinions
Describe how behavioral biases can lead to market characteristics that are unexplained by traditional finance
Momentum: patterns of return where investors follow the leads of others (herding effect)
Bubbles and Crashes: Unusually positive or negative returns
Value vs Growth: Value has tended to outperform growth over time
