BU - Behavioral Finance Flashcards
What is Behavioral Finance?
Study of how emotions affect financial decision making
What is heuristic?
any approach to problem-solving that employs a more practical method that is not guaranteed to be optimal or rational: rules of thumb, educated guess and trial & error
Heuristics reduces the cognitive load of decision making
This ease allows biases to cloud objectivity
SWAG - Silly Wild Ass Guess
What is anchoring?
where an investor sets a value at the initial point of information - typically their buy price
Investor has a price in mind on when they will buy or sell something, that price is what they believe to be the value
What is prospect theory?
people suffer more greatly from losses than they benefit from gains
What is recency bias?
makes investors focus more on the most current events, leading to faulty predictions that this is always how it will always be
What is overconfidence?
people overestimate their knowledge, underestimate risks and exaggerate their ability to control events and predict outcomes.
What factors lead to overconfidence?
Choice task familiarity information (confirmation bias) active involvement past success
What is the disposition effect?
people seek pride and avoid regret
tend to sell winners too quickly
hold losers too long
What kind of risks does an investor take with “house money effect”
take more risk
What kind of risks does an investor take with “snakebite effect”
take less risk
What kind of risks does an investor take with “break-evenitis”
take more risk
Mental Accounting
leads to naïve diversification
assumes that simply investing in enough unrelated assets will reduce risk sufficiently
familiarity leads to ____and single stock conscentration
home bias
Social interactions lead to __________
head mentality - we find comfort in groups/numbers
Optimism can lead to _____
exuberance, which can lead to market bubbles
Objective of asset allocation
To increase your return on investments while decreasing your risk.
Life Cycle & Age
Stage 1: The Early Years - Involves a long period that centers on the accumulation of wealth. Goal setting, insurance, home buying, and family formation are highlighted in terms of planning. The phases included in this stage are Young Adult (18-25), Family Formation (26-35), and Family Development (36-49).
Stage 2: The Golden Years - Involves a shorter period approaching retirement. Financial goals shift to the preservation and continued growth of the wealth already accumulated. The phase included in this stage is Family Maturity (50-60).
Stage 3: The Retirement Years - Involves more spending and less saving. Safety, income, and estate planning take on increased importance. The phase included in this stage is Retirement (60+).
Young Adult Financial Planning Areas
Consumption & Savings Planning
Career Planning
Disability Insurance
Family Formation Financial Planning Areas
Investment Planning Tax Planning Debt Planning Insurance Planning Estate Planning
Family Development Financial Planning Areas
Tax Planning - may involve unexpected events
Investment Planning - regular investing
Insurance Planning- involves planning for the needs of dependents
Retirement Planning - begin long term goal setting
Estate Planning - planning for a sound strategy for protection of wealth
Family Maturity (Golden Years) Financial Planning Areas
Tax Planning - peak earning years, thus tax consideration for loss harvesting or AMT planning
Investment Planning - perhaps more aggressive investing
Insurance Planning -
Retirement Planning - solidify retirement goals to ensure not outliving assets
Estate Planning - reviewing estate documents
Retirement Financial Planning Areas
Investment Planning - allocating to ensure minimal amount of investment risk
Insurance Planning - medical, LTCi, reevaluate life insurance
Retirement Planning - management of savings and assets
Estate Planning - trimming of estate tx bill, reviewing wills, trusts, power of attorney, etc.
