General Principles Flashcards
Heuristics
Experiences or biases that can facilitate problem solving and probability judgements.
Effective for immediate judgement making
Can result in inaccurate or irrational conclusions
Behavioral Finance
The study of bod psychology affects finance
Anchoring
The tendency of investors to become attached to a specific price as the fair value of a holding
Ex: you bought a stock at $100/share and it drops to $50/share. You believe it’s “real” value is around $100 and you are included to hang on since it “should” come back
Attachment Bias
Holding onto an investment for emotional reasons rather than considering more practical applications.
Ex: my grandfather left me stock so I can never sell it
Endowment Bias
The feeling that because you own an asset, it is more valuable and special since it is yours. In reality, you might not even purchase the asset if you did not already own it.
Ex: you inherit a family home and would never sell it even though it has become a money pit
Cognitive Dissonance
The challenge of reconciling two opposite beliefs
Ex: remembering the positive part of an experience but forgetting the negative
Confirmation Bias
The natural human tendency to accept any information that confirms our preconceived position or opinion and to disregard any information that does not suppprt that preconceived notion
Ex: hear about hot stock from unverified source. Do research but only focus on the positive aspects and disregarding any negative aspects
Diversification Errors
Investor tend to diversify evenly across whatever options are presented to them
Ex: 401k participants spending their money across whatever options they have
Fear of Regret
The tendency to take no action rather than risk making the wrong one
Ex: an investor holds onto a stock that’s losing value, because if they sold and it rebounded, they would feel even worse
Financial Infidelity
Couples or partners with shared memory or finances being dishonest with each other
Ex: one partner hiding excessive spending, debts, etc. from the other person
Gambler’s Fallacy
An individual erroneously believe that the onset of a certain random event is likely to happen following an event or a series of events
Ex: investor holds onto a stock after it’s fallen multiple times because they think it’s improbable for it to fall even more
Herd Behavior
The tendency for individuals to minicamp the actions of a large group
FOMO
Hindsight Bias
The 20/20 vision we have when looking at a past event and thinking we understand it, when in reality we may not
Inappropriate Extrapolation
The tendency to look at recent events (or market performance) and assume that those events or conditions will continue indefinitely
Analysis Paralysis
(Paralysis by Analysis)
Individual/couple over analyzing a situation and cannot make a decision (paralyzed) meaning no solution or course of action is decided upon
Fear of making an error outweighs the potential value of success in a decision made in a timely manner. This causes a “paralysis” in the situation
Loss Aversion and Risk Taking
While investors are risk averse to gains, they see risk seekers when it comes to losses (they will take big risk to avoid realizing them)
To avoid the pain of loss, investors have a tendency to hang onto losers
Often investors will leave it up to “chance” instead of sound or rationally informed decision making
Prospect Theory
Described the difference in how people evaluate losses and gains
Researchers found that losses have a much greater negative impact than a commensurate gain will have positive
Mental Accounting
Looking at sums of money differently, depending on their source or the intended use
Outcome Bias
The tendency to make a decision based on the desired outcome rather than on the probability of the outcome
Overconfidence
The tendency to place too much emphasis on one’s own abilities. It is often hand in hand with confirmation bias
Overreaction
Investors emotionally react towards new market information
Over-Weighting the Recent Past
Investors like patterns, and recent past represents a nice easy to find pattern that can become the basis for an investment decision
Self- Affirmation Bias
The belief that when something goes right it is because you were smart and made the right decision. If it goes wrong, it is someone else’s fault or simply bad luck
Spotting Trends that are not there
Investor seek patterns that help support decisions sometimes without adequate confirming research
