Biases & Heuristics

Question 1

What are heuristics?

Answer 1

• These cognitive shortcuts used to produce reliable outcomes sufficiently to be useful.
• Are approaches that “work well enough” for a given situation. Cuts down on the amount of information needed to make a decision.
• Heuristics can be mental shortcuts that ease the cognitive load of making a decision. Examples that employ heuristics include trial and error, a rule of thumb, or an educated guess

Question 2

What is confirmation bias?

Answer 2

• the tendency to seek out information that confirms rather than challenges what we already believe.

Question 3

What is the primacy-recency bias?

Answer 3

The first and last pieces of information are the most salient for you

No ANCHOR POINT for information in the middle

Question 4

Name 3 General Biases and Heuristics that clients experience?

Answer 4

• First/Last
• Emotion
• Frequency

Question 5

Name 3 Planner Tendencies

Answer 5

• Client Acceptance
• Planner Confidence
• Quantitative/Qualitative

Question 6

Belief Perseverance Biases

What is Conservatism Bias?

Answer 6

• Conservatism bias: the tendency to revise one’s belief insufficiently when presented with new evidence

Question 7

Belief Perseverance Biases

What is Confirmation bias?

Answer 7

• Confirmation bias: the tendency to focus on and interpret information in a way that confirms one preconception.

Question 8

Belief Perseverance Biases

What is Cognitive dissonance?

Answer 8

• Cognitive dissonance: the tendency to experience mental stress or discomfort when holding two or more contradictory ideas, beliefs, or values at the same time,
• or when performing an action contradictory to one’s ideas, beliefs, or values, or when confronted by new information that contradicts existing ideas, beliefs or values

Question 9

Belief Perseverance Biases

What is hindsight bias?

Answer 9

• Hindsight bias: the belief that past events were predictable at the time they occurred

Question 10

Belief Perseverance Biases

What is the illusion of control bias?

Answer 10

• The illusion of control: the overestimation of one’s control over external events

Question 11

Belief Perseverance Biases

What is Representativeness bias?

Answer 11

• The tendency to classify things based on a few characteristics without accounting for the base rates of those characteristics

Question 12

Information Processing Biases

What is the Anchoring and Adjustment bias?

Answer 12

• the tendency to rely heavily on one piece of information when making a decision

Question 13

Information Processing Biases

What is the Availability / familiarity / frequency / saliency / recency bias?

Answer 13

• the tendency to overestimate the likelihood of events that are more easily recalled given the recency with which they occurred or the emotional charge they hold

Question 14

Information Processing Biases

What is Framing bias?

Answer 14

• the tendency to draw different conclusions from different presentations of the same information

Question 15

Information Processing Biases

What is self-attribution bias?

Answer 15

• the tendency to claim more responsibility for successes than failures

Question 16

Information Processing Biases

What is sunk-cost bias?

Answer 16

• the decision to invest or spend money, time, effort, etc. despite new evidence that shows that the expected cost of doing so exceeds the expected benefits

Question 17

Information Processing Biases

What is Outcome bias?

Answer 17

• the tendency to judge a decision by its eventual outcome instead of based on the quality of the decision at the time it was made
• The outcome bias is an error made in evaluating the quality of a decision when the outcome of that decision is already known

Question 18

Emotional Biases

What is affinity bias?

Answer 18

• the tendency to be drawn to those people, things or decisions that one views as being similar to themselves

Question 19

Emotional Biases

What is Disposition bias?

Answer 19

• the tendency to sell an asset that has accumulated in value and resist selling an asset that has declined in value

Question 20

Emotional Biases

What is Endowment bias?

Answer 20

• the tendency to overvalue an object because they possess it

Question 21

Emotional Biases

What is loss aversion bias?

Answer 21

• the tendency to view losses as more painful than similar amounts of gains

Question 22

Emotional Biases

What is overconfidence bias?

Answer 22

• the tendency to be overly sure of oneself and their ideas

Question 23

Emotional Biases

What is regret aversion bias?

Answer 23

• the tendency to avoid making decisions for fear of experiencing regret

Question 24

Emotional Biases

What is self-control bias?

Answer 24

• the tendency to choose those actions that provide gratification in the short-term over the long-term

Question 25

Emotional Biases

What is the Status quo bias?

Answer 25

• the tendency to choose to maintain the current situation rather than change

Question 26

Name 7 Types of Heuristics

Answer 26

1. Anchoring
2. Availability
3. Confirmation
4. Denial
5. Herd Behavior
6. Hindsight
7. Overreaction

Question 27

Define the Heuristic of Anchoring

Answer 27

Anchoring: Using irrelevant figures and statistics as a reference point to base future decisions on. There is no substitute for critical thinking.

• relying heavily on one piece of information

Question 28

Define the Heuristic of Availability

Answer 28

Availability: Using available information based on its vividness and emotional impact to base decisions on.

• A barrage of information out there, so people lack expertise in examining and reaching viable conclusions.
• makes people think they are more informed than they are.
• Imagine an outcome and you are more likely to believe it may come true
• tendency to overestimate the likelihood of events that are more easily recalled given the recency with which they occurred or the emotional charge they hold.

Question 29

Define the Heuristic of Confirmation

Answer 29

Confirmation: Look for information that supports your position and avoid info that contradicts it.

• Critical scrutiny may be applied to prove your position yet the other side may be ignored.
• rely on information that will support your own preconceptions

Question 30

Define the Heuristic of Denial

Answer 30

Denial: Avoiding information with negative emotional impact.

• Don’t ask them to imagine the negative outcome as they may think it is even less likely to occur.

Question 31

Define the Heuristic of Herd Behavior

Answer 31

Herd Behavior: People with very little experience fall prey to this behavior. Following a large group whether rational or irrational.

Question 32

Define the Heuristic of Hindsight

Answer 32

Hindsight: Makes rational decision-making more effective.

• Adds to the base knowledge already known from facts and investigation.
• Adding onto already known info…feedback or results of current behavior may reinforce the status quo etc.
• May lead to OVER Confidence…results reinforcing in some way they are better stock pickers than they are
• The belief that past events were predictable at the time they occured.

Question 33

Define the Heuristic of Overreaction

Answer 33

Overreaction: to possibly financial news item that has more significance than is warranted.

• They may overreact and make financial decisions they may regret.

Question 34

What is Prospect Theory and name the 3 types?

Answer 34

1. Joy/Pain function
2. Disposition Effect
3. Hedonic Framing

Question 35

What is the Joy/Pain function of prospect theory?

Answer 35

• People feel pain much more significantly than they do feel joy.
• The joy of gains feels less enjoyable than the pain of losses.
• Better to feel one large loss rather than several small losses,
• Better to have a gain and a loss rather than a net loss.
• May seek to avoid possible losses.
• More willing to settle for small gains if there is a reasonable chance of gaining more

Question 36

What is the Disposition Effect of prospect theory?

Answer 36

• Hold too long to losses and sell to soon on gains.
• Prefers a small gain over a large gain or no gain.
• Risk-averse behavior. On the flip side, a person may take on more risks to avoid small losses.
• In their mind, it is better to avoid the small loss rather than take a large loss or no loss.
• This is not risk adverse behavior.

Question 37

What is Hedonic Framing of prospect theory?

Answer 37

• Pleasure seeking.
• Maximize joy and minimize pain.
• This can minimize the disposition effect. Several small gains can enhance or maximize joy.
• Better here to have a smaller net gain than to have a larger gain and a small loss.
• Take a large loss and small gain rather than a net loss.

Question 38

What is the Winner’s Curse and the difference between the common value auction and the intrinsic value auction?

Answer 38

1. The winners curse: The winner pays a price that is greater than the intrinsic value to the winner and is also greater than the FMV of the item in a broader open market. Number of bidders and their aggressive attitude toward the bidding
2. Common Value auction: winner overpays as they all know roughly the intrinsic value of the item
3. I_ntrinsic value auction_: the winner may overpay because the intrinsic value was much greater to him. An example may be the war medals of his grandfather. Sentimental value. May pay more to have them.

Question 39

What is the Gamblers Fallacy and how do you avoid it?

Answer 39

• is the belief that independent events reoccurring are in fact somehow connected and with each subsequent event your odds to win may somehow be better.
• Simply avoid analyzing the results of previous events and avoid gambling.
• Flip a coin and think because you won a few times your odds may be better than they actually are.