Fundamental Financial Planning Practices

Question 1

Generally, what are the 6 steps in the Planning Process?

Answer 1

1) Establish client-planner engagement
2) Establish objectives and gather data
3) Clarify present status and identify problems and opportunities
4) Identify appropriate strategies and present plan
5) Implement the plan
6) Monitor and Update/Review

Question 2

What are some decision-making heuristics (shortcuts)?

Answer 2

1) Affect Heuristic: The tendency to rely on emotions, rather than concrete information, to make a decision
2) Availability/Recency Heuristic: 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
3) Representativeness Heuristic: The tendency to classify things based on a few characteristics without accounting for the base rates of those characteristics
4) Anchoring and Adjustment Heuristic: The tendency to rely heavily on one piece of information when making a decision

Question 3

What are some emotional biases that may affect decision-making?

Answer 3

1) Loss Aversion Bias: Losses are more painful than gains
2) Overconfidence Bias: Overly sure of oneself
3) Self-Control Bias: Short-term gratification vs. long-term
4) Endowment Bias: Overvaluation of a possession
5) Regret Aversion Bias: Avoiding making a decision for fear of regret
6) Status Quo Bias: Maintain the current situation
7) Disposition Bias: Selling an asset that has increased and resisting for decrease
8) Affinity Bias: Being drawn to people one views as being similar to oneself

Question 4

What is mental accounting?

Answer 4

Mental accounting is the tendency to compartmentalize money to different silos, each of which has a different propensity to spend (ex. extra money, savings to goal).
The three general types of mental accounts are
1) Current Income
2) Assets
3) Future Income

Question 4

What is mental accounting:?

Answer 4

Mental accounting is the tendency to compartmentalize money to different silos, each of which has a different propensity to spend (ex. extra money, savings to goal).
The three general types of mental accounts are
1) Current Income
2) Assets
3) Future Income

Question 5

What are some cognitive biases that are more prevalent in women?

Answer 5

Regret Aversion Bias - avoiding making decisions for fear of a mistake
Representative Bias - fitting a new circumstance in their internal classification system, incorporating past experiences

Question 6

What are some cognitive biases that are more prevalent in men?

Answer 6

Availability Bias - estimating the probability of an outcome based on how prevalent it is in their lives. Easily-recalled possibilities are more likely than outcomes that are harder to imagine
Loss Aversion Bias - rather avoid losses than experience gains