General Principles Ch1

Question 1

Experiences and biases that can facilitate problem solving and probability judgement. Generalizations, “rules-of-thumb”. Often result in irrational or inaccurate conclusions.

Answer 1

Heuristics

Question 2

Examples include:
trial and error
rule of thumb
educated guess

Answer 2

Heuristics

Question 3

Study of how psychology affects finance

Answer 3

Behavioral Finance

Question 4

Happens when one partner, typically a spouse, lies to the other about debts, credit cards, keeps money in a secret account, hides purchases and otherwise hides or lies about money.

Answer 4

Financial infidelity

Question 5

Signs include unexplained withdrawals from accounts, expensive purchases, unfamiliar credit card or bank statements

Answer 5

Financial infidelity

Question 6

Tendency of investors to become attached to a specific price as the fair value of a holding.

Answer 6

Anchoring

Question 7

Holding onto an investment for emotional reasons rather than considering more practical applications.

Example: My grandfather left me this stock so I can never sell it.

Answer 7

Attachment Bias

Question 8

An emotional bias that causes individuals to value an owned object higher, often irrationally, than its real-world market value.

Answer 8

Endowment Bias

Question 9

Happens when the finances of parents and children are inappropriately commingled; may lead to children having a lack of financial motivation and even to lowered confidence and self-esteem.

Answer 9

Financial Enmeshment Bias

Question 10

The challenge of reconciling two opposing beliefs.

Occurs when a person believes in two contradictory things at the same time.

Answer 10

Cognitive Dissonance

Question 11

Investors tend to diversify evenly across what ever options are presented to them.

Example: 401k participants tend to spread their money across whatever options they have.

Answer 11

Diversification Errors

Question 12

Tendency to take no action rather than risk making the wrong one.

Investor holds onto stock that’s losing value because if they sold and it rebounded, they would feel even worse.

Answer 12

Fear of Regret

Question 13

Individual erroneously believes the onset of a certain random even is likely to happen following an event or series of events.

Example: Investor might hold onto a stock that has fallen in multiple sessions because they view further declines as improbable.

Answer 13

Gambler’s Fallacy

Question 14

Tendency for individuals to mimic the actions of a larger group.

Answer 14

Herd Behavior or Fear of Missing Out (FOMO)

Question 15

The 20/20 vision we have when looking at a past even and thinking we understand it, when in reality, we may not.

Example: After a prolonged period of solid returns, stock market drops 15%. Immediately, all kinds of experts appear on television saying we were due for a correction, as if the decline was obvious and inevitable.

Answer 15

Hindsight Bias

Question 16

Tendency to look at recent events or market performance and assume that those events or conditions will continue indefinitely.

Answer 16

Inappropriate Extrapolation

Question 17

Describes an individual/ a couple overanalyzing a situation and can cause decision making to become “paralyzed”, meaning no solution or course of action is decided upon.

When the fear of either making an error outweighs the potential value of success in a decision made in a timely manner. Results in suppressed decision making in an unconscious effort to preserve existing options.

Answer 17

Analysis paralysis

Question 18

While investors are risk ________ when it comes to gains (they do not want to give them up), they are risk ________ when it comes to losses (they will take big risks to avoid realizing them).

Answer 18

averse / seekers

Question 19

Describes different ways people evaluate losses and gains. Losses have a much greater negative impact than a commensurate gain will have positive impact.

Answer 19

Prospect Theory

Question 20

Entails looking at sums of money differently, depending on their source or the intended use.

Example: investing in low interest CDs when you still have mortgage debt at 5% or carry a balance on your credit cards.

Answer 20

Mental accounting

Question 21

The tendency to make a decision based on the desired outcome rather than on the probability of that outcome.

Example: investor wants to double his money in an investment without doing adequate research

Answer 21

Outcome bias

Question 22

Tendency to place too much bias on one’s own abilities. Often works hand in hand with confirmation bias

Answer 22

Overconfidence

Question 23

Investors emotionally react towards new market information

Answer 23

Overreaction

Question 24

Investors like patterns, and recent past represents a nice, easy-to-find pattern that can become the basis for an investment decision.

Answer 24

Over-weighting the Recent past

Question 25

The belief that when something goes right, it is because you were smart and made the right decision. If it does not work out, it is someone else’s fault or simply bad luck.

Answer 25

Self-Affirmation Bias

Question 26

Tendency of investors to do nothing when action is actually called for.

Answer 26

Status Quo Bias

Question 27

Investors seek patterns that help support decisions sometimes without adequate confirming research

Answer 27

Spotting Trends that Are Not There

Question 28

Subconscious beliefs people have regarding money, many of which were developed in childhood.

Answer 28

Money Scripts

Question 29

Negative ideas about wealth; having less is more morally sound; $ = evil

Answer 29

Money avoidance

Question 30

Spend too much; overestimate sense of satisfaction from buying things

Answer 30

Money worship

Question 31

Wealthy but still have higher-than-average financial anxiety

Answer 31

Money vigilance

Question 32

Conflate net worth and self-worth

Answer 32

Money Status

Question 33

A person makes a decision based on whether the various options are presented in a positive or negative way, meaning individuals tend to overlook factual data.

Examples:
If you buy Security 1, you could make a 50% profit.

If you buy Security 1, you could lose everything if anything goes wrong and also miss out on a 50% profit.

Choosing a soap that kills 98% of germs rather than one that allows only 2% of germs to survive.

Answer 33

Framing Effect

Question 34

People have a tendency to view their wealth in nominal dollar terms rather than real terms, which must take inflation into consideration.

Example: A 2% reduction in pay with 0% inflation is deemed worse than a 2% pay increase with 4% inflation. Identical net effect to worker.

Answer 34

Money Illusion

Question 35

FINANCIAL PLANNING PROCESS

Umbrellas
In
A
Downpour
Prevent
Immense
Mess

Answer 35

1. Understanding Client’s Personal & Financial Circumstances
2. Identifying and selecting goals
3. Analyzing current and potential courses of action
4. Developing recommenations
5. Presenting recommendations
6. Implementing recommendations
7. Monitoring progress and updating.