Module 2 Flashcards
1
Q
Behavioral Finance
A
A field of study that relates behavioral and cognitive psychology to financial planning and economics in an attempt to understand why people act irrationally during the financial decision-making process.
2
Q
Risk Tolerance
A
The tradeoff that clients are willing to make between potential risks and rewards, with some probability of negative outcomes. It contributes significantly to a client’s psychological profile and the way decisions are made.
3
Q
Risk Preference
A
The attitude a client has toward financial risks. This is a more constant personal trait.
4
Q
Risk Perception
A
The subjective judgment that clients make when they are asked to describe and evaluate the risk of financial decisions.
5
Q
Risk Capacity
A
Refers to an individual’s financial ability to take on investment risk based on their current financial situation, goals, and obligations. Unlike risk tolerance, which measures an individual’s emotional comfort with risk, risk capacity is an objective measure of how much risk someone can afford to take without jeopardizing their financial future.
6
Q
Risk Literacy
A
The ability of a client to comprehend and act upon information regarding financial risks.
7
Q
Cognitive Biases
A
Often a result of faulty reasoning and typically arise from a lack of understanding of statistical analysis techniques, information processing mistakes, faulty reasoning, or memory errors.
8
Q
Illusion of Control Bias
A
Exists when clients believe they can control or affect outcomes of, say, the market when they cannot.
9
Q
Overconfidence Bias
A
Clients with overconfidence believe their abilities to be much better than they are.
10
Q
Money Illusion
A
The misunderstanding people have in relating nominal rates or prices with real (inflation-adjusted) rates or prices. With this bias, individuals have a tendency to think one dollar has the same value today, tomorrow, and into the future, without considering inflation.
11
Q
Conservatism Bias
A
Occurs when individuals initially form a rational view but fail to change that view as new information becomes available. They consider their original view and the information upon which it is based and do not consider new information important—especially if it is difficult to understand.
12
Q
Hindsight Bias
A
A selective memory of past events, actions, or what was known in the past. Clients have a tendency to remember their correct views and forget the errors. They also overestimate what could have been known.
13
Q
Confirmation Bias
A
Occurs when individuals look for new information or distort new information to support an existing view. Clients who get involved with the portfolio process by researching some of their portfolio holdings may become overly attached to some holdings and only bring up information favorable to the holding.
14
Q
Representativeness Bias
A
The tendency, when making a decision, to recall a past experience similar to the present decision-making situation and assume one is like the other.
15
Q
Base-Rate Neglect
A
When the base rate (probability) of the initial classification is not adequately considered. Essentially, the classification is taken as being 100% correct with no consideration that it could be wrong. A stock could be classified as a value stock, and new information about the stock is analyzed based on that classification. In reality, the stock may not be a value stock.
16
Q
Sample-Size Neglect
A
Makes the initial classification based on an overly small and potentially unrealistic sample of data. For example, the initial classification of the stock could be based on dividend yield without considering any of the other typical characteristics of a value stock.
17
Q
Mental Accounting (Money Jar Mentality)
A
Involves the tendency of individuals to mentally put their money into separate accounts (or money jars) based on the purpose of these accounts. For example, amounts of money may be earmarked separately for savings, debt reduction, and a future vacation. In this case, setting aside money for a vacation while carrying a considerable amount of debt is, in general, poor money management.
18
Q
Cognitive Dissonance
A
When newly acquired information conflicts with pre-existing understanding, people often experience mental discomfort. When in a state of cognitive dissonance, individuals will often change some of their attitudes, beliefs, or behaviors to reduce their discomfort; maintain psychological stability; and feel more balanced.
19
Q
Selective Perception
A
This is when individuals only register information that appears to affirm an already chosen decision. This ties into rationalization or confirmation bias, covered previously.
20
Q
Selective Decision-Making
A
This usually occurs when commitment to an original decision course is high. Selective decision-making rationalizes actions that enable a person to adhere to the original course. An example of this would be an investor who has purchased an investment that has gone down in price because of bad news but continues to invest to not “waste” previously invested or sunk funds.
21
Q
Self-Attribution Bias
A
Individuals take credit for their successes and either blame others or external influences for failures. Self-attribution bias is an ego defense mechanism because analysts use it to avoid the cognitive dissonance associated with having to admit to making a mistake.
22
Q
Self-Enhancing Bias
A
The tendency to claim an irrational degree of credit for successes.
23
Q
Self-Protecting Bias
A
The irrational denial of responsibility for failure.
24
Q
Anchoring
A
Involves individuals making irrational decisions based on information that should have no influence on the decisions at hand. Anchoring is especially risky when people know little about the product being purchased, the service being delivered, or the investment being made.
25
Outcome Bias
The tendency for individuals to take a course of action based on the outcomes of prior events. An investor may choose a particular stock because that stock had superior performance over the past three years. However, this same investor would be ignoring the current conditions that may be applicable to the stock’s performance in the future.
26
Framing Bias
Asserts that people are given a frame of reference—a set of beliefs or values that they use to interpret facts or conditions—as they make decisions. This bias leads individuals to process and respond to information based on the manner in which it is presented. Under this concept, individuals often choose a guaranteed positive outcome (while avoiding a chance of greater gain that also carries the possibility of no gain at all), but they will take a chance to avoid a negative outcome (rather than taking a certain smaller loss).
27
Recency Bias
New information, which is more recent, is considered more important and valuable than less current information.
28
Herding
Is when investors trade in the same direction or in the same securities, and possibly even trade contrary to the information they have available. Herding sometimes makes investors feel more comfortable because they are trading with the consensus of a group. In the context of herding, the recent data or trend becomes the investor’s forecast.
29
Loss Aversion Theory
When clients fear losses much more than they value gains, and prefer avoiding losses to acquiring the same amount in gains.
30
Self-Control Bias
Occurs when individuals lack self-discipline and favor immediate gratification over long-term goals. Consequences and implications of self-control bias may include insufficient savings accumulation to fund retirement needs and taking excessive risk in a portfolio to try and compensate for insufficient savings accumulation.
31
Status Quo Bias
Occurs when comfort with an existing situation leads to an unwillingness to make changes, even though the change is likely beneficial.
32
Endowment Bias
Occurs when an asset is felt to be special and more valuable simply because it is already owned. In other words, once individuals own assets, they irrationally overvalue them, regardless of the assets’ actual value.
33
Regret Aversion Bias
Occurs when individuals do nothing out of excess fear that their decisions or actions could be wrong. They attach undue weight to actions of commission (doing something) and do not consider actions of omission (doing nothing). There is more regret associated with taking an action that turns out poorly than with not taking an action that would have benefited the investor. This is why an individual may put off making any decision at all because of the fear that any decisive action may prove to be less than optimal or an outright mistake.
34
Affinity Bias
The tendency to make decisions based on how individuals believe the outcomes will represent their interests and values. This bias can lead to irrational decisions because investors perceive a product or investment opportunity to be a reflection of themselves. Ethnic, religious, or alumni affiliations can be the source of affinity bias.
35
Money Scripts (Money Beliefs)
Unconscious attitudes regarding money, often a result of childhood experiences, which affect adult perceptions and behaviors. They represent the emotional attachments clients have with money.
36
Exterior Finance
Clients’ traditional financial matters.
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Interior Finance
Clients’ emotional relationships with money.
38
Family-of-Origin Treatment of Money
Parents’ financial circumstances and patterns may greatly influence their children’s beliefs about money and how they value it. As adults, the money principles learned from their families can cause conflict with partners who have different viewpoints.
39
Sources of Financial Conflict
Family-of-origin treatment of money, inadequate communication, different risk tolerance levels, adult children, blended families, cultural differences, & inheritances.
40
Economic & Resource Counseling Approach
Clients are assumed to be rational and will change to the most favorable behavior if given the appropriate counseling. In this approach, the financial planner is the agent of change. The focus is on obtaining and analyzing quantitative data, such as cash flow, assets, and debt.
41
Classical Economics Counseling Approach
Clients choose among alternatives based on objectively defined cost-benefit and risk-return tradeoffs. The belief in this approach is that increasing financial resources or reducing financial expenditures results in improved financial outcomes.
42
Strategic Management Counseling Approach
A client’s goals and values drive the client-planner relationship. Conducting a SWOT analysis (identifying strengths, weaknesses, opportunities, and threats) is done early in the financial planning process.
43
Cognitive-Behavioral Counseling Approach
Clients’ attitudes, beliefs, and values influence their behavior. Planners use this approach in an attempt to substitute negative beliefs that lead to poor financial decisions with positive attitudes, which should result in better financial results.
44
Psychoanalytic Counseling Approach
Based on the use of psychoanalytic theory, such as Freudian psychodynamic theory or Gestalt theory, this approach is not widely used by planners.
45
Social Penetration Theory
Outlines the four stages in which relationships, such as those between clients and their planners, develop and progress:
1. Orientation
2.Exploration
3. Affective Exchange
4. Stable Exchange
46
Orientation
The first stage of social penetration begins even before the client and the planner’s first meeting. Marketing messages, initial telephone or email communication, and the planner’s office environment all influence how clients become familiar with the financial planning process.
47
Exploration
The second stage of social penetration. Clients and planners begin to discuss the financial planning process in more detail. This includes a discussion of the client’s financial goals and perceptions, and also involves learning more about the client. For example, in this stage, the planner seeks to understand the client’s beliefs, attitudes, feelings, and perceptions.
48
Affective Exchange
The third stage of social penetration. The planner-client relationship becomes one of significant trust. Without reservation, clients share their true feelings, aspirations, goals, and concerns in this stage. The relationship may become more of a friendship. This stage is represented by open disclosure, sincerity, and intimacy.
49
Stable Exchange
The fourth stage of social penetration. When client and planners have developed a consistent and established pattern together. The pattern is most often represented by open, uninhibited, friendly, and meaningful conversations.
50
1. How clients perceive risk can directly affect their risk tolerance. Which of the following correctly describes risk perception?
A. It is the degree to which a client’s financial resources can mitigate risk.
B. It is the ability to comprehend and act upon information regarding financial risks.
C. It is the subjective judgment clients make when they are asked to describe and evaluate the risk of financial decisions.
D. It is the tradeoff that clients are willing to make between potential risks and rewards, with some probability of negative outcomes.
C. It is the subjective judgment clients make when they are asked to describe and evaluate the risk of financial decisions.
Explanation: Risk perception is the subjective judgment clients make when they are asked to describe and evaluate the risk of financial decisions. Risk capacity is the degree to which a client’s financial resources can mitigate risk. The ability to comprehend and act upon information regarding financial risks is known as financial literacy. Risk tolerance is the trade-off that clients are willing to make between potential risks and rewards, with some probability of negative outcomes.
51
2. Which of the following statements regarding psychological profiling is CORRECT?
I. Many financial planners conduct fact-finding interviews in which they acquire information regarding how their clients process information, make decisions, and behave socially.
II. Closed-ended questions—those that require the clients to answer in their own words—should be used to gain a reliable psychological profile.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
A. I only
Explanation: The answer is I only. Statement II is incorrect. Open-ended questions should be used to gain a reliable psychological profile.
52
3. Which of the following statements regarding attitudes and values is CORRECT?
I. Values reflect a person’s opinions and wants.
II. Beliefs are a type of attitude because they reveal a person’s understanding of some aspect of their life.
III. A client’s context can be affected by their cultural influences, religious preferences, and individual family circumstances.
IV. A planner should recognize their own attitudes, values, biases, and behaviors and be certain that they do not impact recommendations made to clients.
A. IV only
B. III and IV
C. I, II, and III
D. II, III, and IV
D. II, III, and IV
Explanation: Attitudes, not values, reflect a person’s opinions, values, and wants. Values are attitudes and beliefs for which a person feels strongly; they represent what a person believes to be right. The other statements are correct.
53
4. In 2014, the average cost of a new home in Kensington Square was $250,000. In 2017, to the disappointment of many prospective homeowners, the average home cost rose to $300,000. Then, in 2019, the average cost of a new home fell to $275,000. The reaction to the decreased cost was positive, though the new average cost was higher than the 2014 average cost of a new home. This behavior is known as:
A. anchoring.
B. money illusion.
C. confirmation bias.
D. mental accounting.
A. anchoring.
Explanation: When the average cost of a new home rose in 2017 to $300,000, individuals reset their psychological anchors to that cost. As the price declined in 2019 to $275,000, the reaction was positive because it was considered in light of the higher 2017 price.
54
5. Arnie has accumulated $15,000 in a savings account over the last few years and has earmarked that money to buy a new car. His furnace breaks and requires $9,000 in repairs. Arnie is reluctant to spend the money in his savings account to make the repairs because he wants to use that money for a new car. Instead, he puts the $9,000 repair bill on his credit card at an annual interest rate of 23%. This is an example of which of the following behaviors?
A. Herding
B. Illusion of control
C. Conservatism bias
D. Mental accounting
D. Mental accounting
Explanation: This represents mental accounting because Arnie’s irrational financial decision resulted from mentally putting his money into separate accounts based on the function of those accounts. Herding occurs when a person follows the actions of a larger group, whether rational or not. Illusion of control bias exists when clients believe they can control or affect outcomes of, say, the market when they cannot. Conservatism bias occurs when market participants initially form a rational view but fail to change that view as new information becomes available.
55
6. John has a strong feeling about a particular investment’s future performance. He is constantly seeking information to validate his belief that this investment will greatly appreciate. However, he is dismissing any information that is contradictory to his stance. This is an example of which of the following?
A. Framing
B. Recency bias
C. Anchoring
D. Confirmation bias
D. Confirmation bias
Explanation: This scenario is an example of the confirmation bias, which states that investors tend to look for information that supports their previously established decisions and beliefs.
56
7. Your client Rosita purchased a stock two years ago at $45 per share, and it is currently trading at $25 per share. Though the prospects for the company do not look good, she does not want to sell the stock until she can at least break even. Rosita is likely exhibiting what emotional bias?
A. Self-control
B. Status quo
C. Loss aversion
D. Affinity
C. Loss aversion
Explanation: Loss aversion, which is not wanting to take a loss and is related to the fear of regret, explains why Rosita will not sell the stock at a loss.
57
8. Five years ago, Stuart invested $125,000 in Collegiate Construction Co., the company that built a new football stadium for his alma mater, Cedarwood College, at cost. You have looked at Stuart’s portfolio and concluded that the Collegiate stock represents over half of Stuart’s total net worth. You recommend that he sell most of the stock so he can diversify his portfolio. Stuart responds that he cannot carry out your recommendation because Collegiate was so good to Cedarwood to provide an affordable stadium. This is an example of what emotional bias?
A. Affinity
B. Endowment
C. Self-control
D. Overconfidence
A. Affinity
Explanation: This is an example of affinity bias. Stuart favors Collegiate Construction Co. stock because he identifies with it emotionally. Collegiate built a stadium at cost for his alma mater. Endowment bias occurs when an asset is considered special and more valuable simply because it is already owned. Self-control bias occurs when individuals lack self-discipline and favor immediate gratification over long-term goals. Overconfidence leads clients to believe they can control random events merely by acquiring more knowledge and consider their abilities to be much better than they are.
58
9. Which of the following statements regarding financial transparency is CORRECT?
A. Partners should be transparent regarding their finances only if they have joint accounts.
B. It is important that partners always share financial goals and values.
C. Partners should be open about assets owned separately or debt incurred on their own.
D. If partners appear uncomfortable discussing the details of their finances, the planner should, at the very least, get an overview of them.
C. Partners should be open about assets owned separately or debt incurred on their own.
Explanation: Partners must be clear and unambiguous about income, spending, assets, and liabilities. Ideally, this should be the case even when couples have separate accounts, assets, or debt, especially if there are common goals shared by partners. It is important that partners share values and goals, or at least respect goals that differ and have agreement about how they should be met with their resources. When decisions related to family financial goals are discussed openly, the planner can make relevant recommendations that will put clients on track to meet the agreed-upon goals. This requires that partners provide details of their finances.
59
10. Which of the following statements regarding financial conflict is CORRECT?
A. To identify potential financial conflict, financial planners should place more emphasis on what partners discuss than how they discuss it.
B. Nonverbal behaviors, which are important to notice, are not as important as spoken words.
C. To avoid conflict, if partners have comparable retirement account balances, it is preferable for each partner to invest according to their own individual risk tolerance.
D. To lessen conflict between parents and adult children they support, it is wise to have general conversations regarding expectations for each party.
C. To avoid conflict, if partners have comparable retirement account balances, it is preferable for each partner to invest according to their own individual risk tolerance.
Explanation: If retirement account balances are comparable, it is often a good strategy to have each partner investing according to their own risk tolerance. To identify potential financial conflict, financial planners should give equal importance to what partners say and how they say it. Nonverbal behaviors, which are important to notice, are equally important as the spoken word. To lessen conflict between parents and adult children they support, it is wise to establish realistic guidelines with the adult children, preferably in a written agreement with detailed terms.
60
11. Analyze the scenario. Riva is meeting with Ekram, a financial planner, to review his planning recommendations. During their discussion, Riva explains to Ekram her concern about not having enough money saved for retirement if she follows his recommendations. Meanwhile, Ekram is thinking about a call he received earlier in the day about minor issues his child is having in school. After a minute or so, he realizes he did not hear everything Riva has said to him. He would like to wrap up his meeting with Riva so he can call his son’s teacher. What is the most appropriate action for Ekram?
A. He should try to pay attention and call Riva later for clarification if he missed anything.
B. He should ask Riva closed-ended questions to understand her concerns, in an attempt to end the meeting as quickly as possible.
C. He should tell Riva that he will adjust his retirement recommendations based on what he’s already heard and end the meeting.
D. He should apologize to Riva for being distracted and ask her to begin again, this time paying full attention to what she is saying.
D. He should apologize to Riva for being distracted and ask her to begin again, this time paying full attention to what she is saying.
Explanation: Ekram should apologize to Riva for being distracted and ask her to begin again, this time paying full attention to what she is saying. The financial planner has the responsibility to engage in effective communication. Ekram was not actively listening to what Riva was saying. Though he was distracted only for a minute or so, Riva may have said something significant during that time. Asking closed-ended questions or trying to act on what he’s already heard is not in Riva’s best interest and would not be considered effective communication.
61
The loss aversion theory of behavioral finance states that people tend to:
A) consider their abilities to be much better than they actually are.
B) make irrational decisions based on information that should have no influence on the decision at hand.
C) fear losses much more than they value gains.
D) follow the actions of a larger group, whether rational or not.
C) fear losses much more than they value gains.
62
Rochelle is presented with two equal investment opportunities. The first is stated in terms of potential losses, and the second is stated in terms of potential gains. Without having any additional information, Rochelle selects the second investment. Her decision reflects:
A) anchoring.
B) loss aversion theory.
C) the framing bias.
D) herding
B) loss aversion theory.
63
Which of these forms of financial manipulation is correctly described?
I. Financial enmeshment most often involves one partner being more financially literate than the other.
II. Financial abuse is controlling an individual's ability to use, obtain, or possess financial resources.
A) Both I and II
B) II only
C) Neither I nor II
D) I only
B) II only
Explanation: Financial enmeshment, or financial enabling, most often involves supporting an adult who should not need to dependent on the enabler. This typically occurs in a parent-child relationship, but can also be the case between siblings, other relatives, or friends who often see their own financial wellbeing decline when they provide the financial support. Financial control often involves one partner being more financially literate than the other.
64
Which of these statements regarding interpersonal communication between financial planners and their clients are CORRECT?
I. Mirroring is accomplished by imitating the client's body language or verbal style.
II. Effective interpersonal communication involves the application of oral skills only.
III. Body language can impact how clients receive and interpret messages more than any other type of communication.
IV. Emotional intelligence includes the ability to recognize clients' expressions and select socially appropriate responses.
A) I and IV
B) II and III
C) I, II, and III
D) I, III, and IV
D) I, III, and IV
65
Which of the following statements regarding behavioral finance concepts is CORRECT?
I. A client's values represent what he believes to be right.
II. Beliefs are a type of attitude because they reveal a person's understanding of some aspect of his life.
III. A client's profile is largely influenced by context, which includes past history or any conditions that presently exist.
IV. A planner should recognize his own attitudes, values, biases, and behaviors and be certain they do not impact recommendations made to clients.
A) I, II, III, and IV
B) II and IV
C) II, III, and IV
D) III only
A) I, II, III, and IV
66
Which of these statements regarding counseling theory is CORRECT?
I. In the classical economics approach to financial counseling, it is believed that improved financial outcomes can result from increased financial resources or reduced financial expenditures.
II. Financial counseling is a process in which the planner helps a client change poor financial behavior by making recommendations to improve financial status.
III. Planners using the economic and resource approach assume clients are rational and will change to the most favorable behavior if given the appropriate counseling
IV. The cognitive-behavioral approach to financial counseling asserts that clients' attitudes, beliefs, and values influence their behavior.
A) II only
B) I and IV
C) II, III, and IV
D) I, III, and IV
D) I, III, and IV
67
Which of these statements best describes representativeness?
A) People tend to follow the actions of a larger group, whether rational or not in a particular case.
B) People often make irrational decisions based on information that should have no influence on the decision at hand.
C) People often consider their investment abilities to be much better than they actually are.
D) People believe the past will persist and will classify new information based on past experience or classification.
D) People believe the past will persist and will classify new information based on past experience or classification.
68
Roberto is meeting with his clients, Saul and Betsy, to define their goals. Saul is excited when he explains to Roberto his plans to purchase a new off-road vehicle. Betsy folds her arms and grimaces. What is the best action for Roberto to take next?
A) Ask Betsy if the off-road vehicle is a mutually agreed-upon goal.
B) Get more details regarding the purchase of the off-road vehicle.
C) Recommend how Saul and Betsy can pay for the off-road vehicle.
D) Ask Saul and Betsy if they have any other goals.
A) Ask Betsy if the off-road vehicle is a mutually agreed-upon goal.
69
When newly acquired information conflicts with pre-existing understanding, people often experience mental discomfort, also known as cognitive dissonance. All of the following are characteristics of cognitive dissonance except:
A) Taking credit for individual successes and blaming others or external influences for failures
B) Individual changes in attitudes, beliefs, or behaviors to reduce discomfort
C) Rationalizing actions in order to adhere to the original course
D) Registering only information that appears to affirm an already chosen decision
A) Taking credit for individual successes and blaming others or external influences for failures
Explanation: Self-attribution bias is an ego defense mechanism in which individuals take credit for their successes and either blame others or external influences for failures.
70
Which of these statements regarding counseling theory is CORRECT?
I. In the classical economics approach to financial counseling, it is believed that improved financial outcomes can result from increased financial resources or reduced financial expenditures.
II. Planners using the economic and resource approach assume clients are rational and will change to the most favorable behavior if given the appropriate counseling.
III. Financial counseling is a process in which the planner helps a client change poor financial behavior by making recommendations to improve financial status.
IV. The cognitive-behavioral approach to financial counseling asserts that clients' attitudes, beliefs, and values influence their behavior.
A) I and IV
B) I, II, and IV
C) II only
D) II, III, and IV
B) I, II, and IV
Explanation: The belief in the classical economics approach is that increasing financial resources or reducing financial expenditures results in improved financial outcomes. Rational clients are assumed when using the economic and resource approach. The cognitive-behavioral approach to financial counseling believes that clients' behaviors are influenced by their attitudes, beliefs, and values. Financial counseling is a process that helps clients change their poor financial behavior through education and guidance. Making recommendations to improve clients' financial statuses is not part of financial counseling.
71
During a meeting with his financial planner, Jack asks, "Should I be investing in the stock market to meet my savings goals?" The planner answers, "That depends. How do you feel about the possibility that your investment may decline in value?" The planner's answer is an example of:
A) a leading response.
B) verbal mirroring.
C) emotional intelligence.
D) physical mirroring.
A) a leading response.
72
Ernie sees himself as a consultant to his clients and allows their goals and values to drive his relationships with them. What is his approach to financial counseling?
A) Classical economics approach
B) Cognitive-behavioral approach
C) Strategic management approach
D) Economic and resource approach
C) Strategic management approach
73
What types of questions should be used to develop a client’s psychological profile?
Open-ended questions—those that require the clients to answer in their own words.
74
What type of learner will express themselves through facial expressions and often have interests such as movies and spectator sports?
Visual learner.
75
What type of learner will express themselves through words and often enjoy music and conversation?
Auditory learner.
76
What kind of learner will express themselves through body language and tend to enjoy physical activities?
Kinesthetic learner.
77
Consequences and implications of illusion of control may lead clients to:
trade more than is appropriate because they mistakenly believe they can control the outcome of a trade or are overconfident in their analysis,
neglect to take advantage of an investment opportunity due to their beliefs that they have greater control over less suitable investments, or
fail to adequately diversify.
78
Illusion of control detection starts with realizing:
investment results are typically based on probability.
79
Research has shown that traders with higher levels of illusion of control perform better/poorer (?) than those with lower levels.
Poorer.
80
Money illusion also may cause clients to:
dismiss small numbers without putting them into the correct financial perspective. This misunderstanding can lead to poor financial decisions or cloud clients’ financial judgment.
81
Consequences and implications of conservatism may include clients who are:
unwilling or slow to update a view and, therefore, hold an investment too long; or
hold an investment too long to avoid the mental effort or stress of updating a view.
82
Consequences and implications of hindsight bias may include individuals who do the following:
Overestimate the rate at which they correctly predicted events that could reinforce an emotional overconfidence bias, discussed in the reading in this module titled Emotional Biases.
Become overly critical of the performance of others. For example, they might criticize the stock selections of an analyst whose recommendations underperformed the market when the recommendations outperformed the market groups for which the analyst was responsible.
83
To identify hindsight bias, ask questions such as:
“Does my client really remember what he/she predicted and recommended?”
84
Consequences and implications of confirmation bias may include clients who:
consider positive but ignore negative information and, therefore, hold investments too long;
set up the decision process or data screens incorrectly to find what they want to see;
under-diversify as they become overly convinced their ideas are correct, or overconcentrate in the stock of their employer, believing they have an information advantage in that security; or
fail to adequately diversify.
85
Representativeness appears when investors become:
overly negative about investments that have done poorly in the past and overly positive about investments that have done well in the past. From this, stocks, in particular, can become undervalued or overvalued. In addition, individuals place too much value on what they know based on their experiences—and this familiarity can be confused with knowledge.
86
What are the two forms of representativeness?
Base rate neglect
Sample-size neglect
87
Consequences and implications of representativeness bias may include market participants who:
attach too much importance to new pieces of information and have excessive turnover; or
make decisions based on simple rules of thumb and classification without thorough and more difficult analysis, attaching either too much or too little importance to new information.
88
What are the two primary aspects of cognitive dissonance in decision-making?
Selective perception.
Selective decision-making.
89
Which bias does the following situation represent?
Tony and Devi requested that their broker, Tom, purchase Newberry stock on their behalf. After one year, the stock price has fallen considerably. Tony and Devi rationalized their decision to buy the stock by telling others that it was Tom who made the decision to buy the stock for them. In reality, it was their decision—not Tom’s. Furthermore, Tony and Devi continue to invest in Newberry because they do not want to “waste” previously invested funds.
Cognitive dissonance.
90
Which bias does the following situation represent?
Though Amara’s financial planner has advised her to consider investing internationally, Amara believes herself to have more control of investments in companies solely in her own country because they’re “closer to home.” Therefore, she missed an opportunity to considerably increase the value of her investment portfolio by investing in international companies.
Illusion of control.
91
Which bias does the following situation represent?
Rasheeda has invested $2,000 in ABC stock. One year later, the stock price increases by 5%; so, ABC stock is worth $2,100. Rasheeda sells the stock and deposits the proceeds in her bank account. Because she has deposited $100 more into her account than she had a year ago, Rasheeda feels well-off. Over the last year, the rate of inflation was 6%. Therefore, the $2,100 is worth a mere $1,981, so when considering inflation, Rasheeda actually was at a deficit.
Money illusion.
92
Which bias does the following situation represent?
Two years ago, Tania invested in Brown Pharmaceuticals when she learned that the company was changing from a five-day to an overnight delivery of medication to patients nationwide. At the time, Brown was the only company in the pharmaceutical industry to do this, and the price of Tania’s stock rose. Last month, however, Tania found out that Brown violated safe laboratory practices and may be fined over $1 million, which will likely result in its stock price falling. Tania will subconsciously weigh the shipping information as more important because she does not understand laboratory practices. Therefore, she will not consider selling her Brown Pharmaceuticals stock.
Conservatism bias.
93
Which bias does the following situation represent?
Rachel purchased stock in Roth Enterprises, and shortly thereafter, the Roth stock price fell. Afterward, Rachel believed she knew the price would go down. When in reality, she did not have the information necessary to predict the outcome. It was only later when the stock price fell did it become apparent and expected. Here, Rachel has overestimated the accuracy of her own judgment. Had she known the stock price was going to fall, she likely would have never initially purchased the stock.
Hindsight bias.
94
Which bias does the following situation represent?
Brenden has been employed by RBC Electronics for 25 years, and he feels he has more information as an employee of RBC than those who are not employed by the company. This, in fact, is not the case. Based on his perception, Brenden invests most of his portfolio in RBC stock. This will result in under-diversification of Brenden’s portfolio, may likely increase his risk, and may subject him to losses that could have been mitigated had his portfolio been more diverse.
Confirmation bias.
95
Which bias does the following situation represent?
Ashleigh, an analyst, forecasts the future earnings of Gamer’s Galaxy stock using the short-term history of high earnings she has noticed. These estimates were then used to price Gamer’s stock. The result was stock overpricing because the high earnings growth observed by Ashleigh was only a small sample relative to the irregular longer-term history of Gamer’s stock. The future earnings were lower than forecasted, and Gamer’s stock price actually dropped substantially.
Representativeness bias.
96
Which bias does the following situation represent?
Julian has saved $15,000 for a Mediterranean cruise he plans on taking in six months. Unfortunately, his roof recently began leaking, and it requires repairs costing $10,000. Julian does not want to spend the money he has saved for his vacation to make the repairs. Instead, he withdraws $10,000 from his traditional IRA to make the repairs. He has to pay income tax plus a 10% penalty on the IRA withdrawal. Julian’s irrational financial decision resulted from mentally putting his money into separate accounts (e.g., for vacation) based on the function of those accounts.
Mental accounting/money jar mentality.
97
What are the two primary types of self-attribution bias?
Self-enhancing bias
Self-protecting bias
98
Which bias does the following situation represent?
Noah invested in various stocks over the years, and has seen the value of his portfolio increase considerably up until last year. He has boasted to his colleagues for several years that his good fortune is the result of his investment expertise. This year, however, the stock market did poorly, and Noah decided to sell most of his stock at a low point, resulting in a significant loss. Had Noah waited to sell his stock when it rebounded, he would have fared better. The major loss he experienced as a result of selling his stock at a low price, he said, was not due to his error, but the economy.
Self-attribution bias.
99
Individuals with a strong ?? bias are often difficult to work with as clients. They often would not acknowledge the help and good advice that an advisor has provided; rather, they would think that they “would have done it anyway.” However, for any perceived bad advice, they would lay the blame for it squarely on the shoulders of the advisor.
Self-attribution.
100
Which bias does the following situation represent?
In the late 1990s, it appeared that investors could do no wrong by buying technology stocks and, no matter what prices were paid, technology stock prices would be higher in the future. However, though valuations went to extremes and it became evident that the prospect of any earnings for many of these companies was well into the future, if ever, many investors did not react to this information. By the end of 2002, significant losses were experienced.
Anchoring.
101
Which bias does the following situation represent?
Amelia’s friend, Olivia, tells Amelia that last year she received a very high return on an investment she made. Amelia, hoping to experience a high return as well, made the same investment. Due to a major economic downturn before Amelia made her investment, she actually lost money. Had Amelia considered the negative economic outlook, she likely would not have made the investment. Instead, her decision to invest was based on the outcome of Olivia’s investment and not on current economic conditions.
Outcome bias.
102
Scenario 1. You have been given $1,000 and have the following choices:
Option A: You can receive another $500.
Option B: You can flip a coin, and if it is heads, you receive another $1,000; if it is tails, you get nothing.
Scenario 2. You have been given $2,000 and have the following choices:
Option A: You can lose $500.
Option B: You can flip a coin, and if it is heads, you lose $1,000; if it is tails, you lose nothing.
Those with framing bias will choose Option ? in the first scenario and Option ? in the second. Here, they are focusing on gains and losses and are not considering the overall effect on their wealth.
Option A; Option B
If you examine both scenarios closely, you will realize they have identical choices. In both cases, you will receive $1,500 for certain if you choose Option A, or else have a 50/50 chance of either ending up with $1,000 or $2,000 if you pick Option B. Therefore, the best choice is to choose the same option under either scenario. Which option you prefer is up to you, but if you choose Option A in the first scenario, you should also choose Option A in the second (and same process for Option B). Framing bias exists when you choose different letter answers in the two scenarios because of how the questions are asked—in other words, how they are framed.
103
Which bias does the following situation represent?
The sharp decline in the stock market during the financial crisis in 2007–2008 caused many investors to shy away from the stock market. A main reason for this is that investors believed there was a high possibility of another stock market crash. Although this crisis was a unique circumstance likely not to happen again for many years, the fact that they had a recent recollection of the crisis resulted in a ? bias that caused them to be extremely cautious about investing in stocks.
Recency bias.
104
When trying to overcome or mitigate biases (errors) that are both emotional and cognitive, success is more likely to be achieved by focusing on the:
cognitive issues.
105
A “get-even-itis” attitude can be very harmful to investment results because:
some stocks never will get back to the price at which an investor bought them or, even if the price does increase, it may take a very long time. In the meantime, better investments are passed by while waiting for the stock to rebound. In this case, what investors do not do can be as harmful as what they do.
106
Which bias does the following situation represent?
Zack recommends that Nicholas invest in Fund A, which has had an average gain of 7% over the past three years, with above-average gains in some years and losses in others. The following day, Alex meets with Nicholas to discuss investing. Alex suggests that Nicholas invest in Fund A, which has had an (average gain of 7% over three years). Nicholas would be more likely to invest with Alex, who presented Fund A with an overall gain of 7% instead of a combination of both above-average gains in some years and losses in others.
Loss aversion theory.
107
Which bias does the following situation represent?
Anjay has worked in the biotechnology industry for over 30 years. He is an experienced biotechnologist who has participated in leading-edge food safety research. Because he has vast experience in this field, Anjay feels he has a higher ability to trade stocks within the biotechnology industry than other investors.
Overconfidence.
108
Which bias does the following situation represent?
Zola has met with her financial planner, Aaron, several times over recent years to plan for her retirement. During this time, Aaron has created a plan that will allow Zola to have the retirement lifestyle she desires, but to date, Zola has been unable to save according to plan due to her love of expensive and exotic travel. Until she can learn to focus on her long-term retirement goal instead of the immediate gratification of travel, she will not be able to adequately save for retirement.
Self-control bias.
109
Consequences and implications of status quo bias may include:
holding portfolios with inappropriate risk, and
not considering other better investment options.
110
Which bias does the following situation represent?
Isabella, among other assets, inherited a risky Aquarius Technologies stock from her grandfather, Carmelo. She sought the advice of Ethan, a financial planner, so she could create an investment portfolio based on her conservative risk tolerance. After meeting with Isabella on several occasions and gathering relevant information, Ethan recommended that Isabella sell the Aquarius stock and invest in stocks more suited to her risk tolerance. Isabella neglected to follow Ethan’s recommendation and retained the Aquarius stock because she felt uncomfortable making the change, even though it would be a wise decision.
Status quo bias.
111
Which bias does the following situation represent?
Ryder is asked what his minimum sales price would be for an antique car he owns, and he responds, “$20,000.” However, he says that the maximum purchase price he would pay to purchase an identical car would be $16,000. Ryder would sell the car at a price higher than he would pay for it. Because Ryder owns the car, he believes it is worth more than he would pay to purchase it.
Endowment bias.
112
Consequences and implications of regret aversion may include the following:
Excess conservatism in the portfolio may occur because it is easy to see that riskier assets occasionally underperform. Therefore, clients avoid riskier assets to prevent the regret experienced when they decline.
Regret aversion leads to long-term underperformance and a failure to meet goals.
Herding behavior is a form of regret aversion where participants go with the consensus or popular opinion. Essentially, the participants tell themselves they are not to blame if others are also wrong.
113
Which bias does the following situation represent?
After holding shares for several years with mediocre returns, Emilio decides to sell his shares in Zoom Racing Company. Shortly after the sale, the price of Zoom stock soars, and Emilio has regret for selling the stock when he did. Months later, Emilio’s financial planner suggests he sell his Advantage Airlines stock due to its poor performance. Emilio tries to minimize his regret of selling the Zoom stock by not selling the poor-performing Advantage stock. He does not want to take the risk that selling would again be the worse option.
Regret aversion bias.
114
Which bias does the following situation represent?
Brody is an avid fisherman and hunter who loves the outdoors. He frequently spends an afternoon at Sports World, his favorite hunting, fishing, and camping store, shopping for sporting gear. Because he enjoys shopping at Sports World, he tells his financial planner, Kaci, that he would like to invest in its stock. Kaci researches the stock, and reports back to Brody that because the stock has a poor outlook for future performance, it would be a poor investment decision. Brody invests in Sports World anyway.
Affinity bias.
115
A planner's ability to recognize emotional expressions in herself and the client and to select socially appropriate responses to the circumstances and the client's emotions is known as:
A) mirroring.
B) body language.
C) emotional intelligence.
D) active listening.
C) emotional intelligence.
116
Brynlee has a kinesthetic learning style. Which of the following statements regarding Brynlee is CORRECT?
i. She is likely to enjoy physical activities.
ii. She expresses herself with body language.
iii. Graphs, charts, and pictures are useful in presenting information to Brynlee.
A) II Only
B) III Only
C) I and II
D) I, II, and III
C) I and II
Explanation: Statement iii. describes clients with a visual learning style.
117
Phan's father, Ren, passed away two years ago. As part of Phan's comprehensive financial plan, his financial planner recommends that Phan sell the ABC stock he inherited from Ren. Because Ren purchased the stocks on the day Phan was born, they are sentimental to Phan and he doesn't want to sell. This best describes what type of emotional bias on Phan's part?
A) Status quo bias
B) Overconfidence
C) Endowment bias
D) Regret-aversion bias
C) Endowment bias
Explanation: Endowment bias occurs when an asset is considered special and more valuable because it is already owned.
118
Which of the following may be affected by a client's risk tolerance and risk perception?
I. Investment decisions
II. Decisions concerning insurance coverage
III. Decisions concerning types and amount of mortgages
IV. Decisions concerning pension payout options
A) II and IV
B) I, II, III, and IV
C) I only
D) I, II, and III
B) I, II, III, and IV
Although risk tolerance and risk perception are most often associated with investing, they may affect all of these financial decisions.
119
Under some circumstances, financial planners attempt to substitute clients' negative beliefs that lead to poor financial decisions with positive attitudes that should result in better financial results. This represents what approach to financial counseling?
A) Strategic management approach
B) Economic and resource approach
C) Classical economics approach
D) Cognitive-behavioral approach
D) Cognitive-behavioral approach
Using the cognitive-behavioral approach, planners attempt to help clients make better financial decisions. Improved client attitudes, beliefs, and values should influence better behavior.
120
The behavioral finance concept that asserts that people are given a means of reference, a set of beliefs or values, which they use to interpret facts or conditions as they make decisions, is known as
A) confirmation bias.
B) framing bias.
C) anchoring.
D) mental accounting.
B) framing bias.
The framing bias asserts that people are given a frame of reference, a set of beliefs or values, which they use to interpret facts or conditions as they make decisions. Anchoring is making irrational decisions based on information that should have no influence on the decision at hand. Confirmation bias is paying attention to information that supports a preconceived opinion and poorly made decision, while disregarding accurate, unsupported information. Mental accounting is putting money into separate "accounts" based on the function of these accounts.
121
Unconscious attitudes regarding money, often as a result of childhood experiences, which affect adult perceptions and behaviors are known as
A) financial comfort zones.
B) financial enabling.
C) financial dependencies.
D) money scripts.
D) money scripts.
Financial dependencies involve the reliance on others for income not related to employment, most often creating a fear that the person(s) providing the support will stop the cash flow at any time. Financial enabling is where an individual agrees to provide financial assistance to another even though it may put the individual's own financial well-being at risk. Financial comfort zones represent financial circumstances in which individuals are content and unconcerned about their financial well-being.
122
Brittany's mother, Joan, passed away two years ago. As part of Brittany's comprehensive financial plan, her financial planner recommends that Brittany sell the ABC stock she inherited from Joan. Because Joan purchased the stocks on the day Brittany was born, they are sentimental to Brittany and she doesn't want to sell. This best describes what type of emotional bias on Brittany's part?
A) Endowment bias
B) Overconfidence
C) Regret-aversion bias
D) Status quo bias
A) Endowment bias
This is an example of endowment bias, which occurs when an asset is felt to be special and more valuable simply because it is already owned.
123
Which of these statements regarding financial transparency is CORRECT?
I. It is important that partners always share financial goals and values.
II. Partners should be open about assets owned separately or debt incurred on their own.
III. Partners should be transparent regarding their finances only if they have joint accounts.
IV. If partners appear uncomfortable discussing the details of their finances, the planner should, at the very least, get an overview of them.
A) III and IV
B) I and IV
C) II only
D) I and II
C) II only
Partners must be clear and unambiguous about income, spending, assets, and liabilities. Ideally, this should be the case even when couples have separate accounts, assets, or debt, especially if there are common goals shared by partners. It is important that partners share values and goals, or at least respect goals that differ and have agreement about how they should be met with their resources. When decisions related to family financial goals are discussed openly, the planner can make relevant recommendations that will put clients on track to meet the agreed-upon goals. This requires that partners provide details of their finances.
124
Which of these questions regarding cultural humility is CORRECT?
I. Planners honestly make an effort to understand clients' identities.
II. It involves evaluation in which planners critically consider their clients' beliefs only.
A) Neither I nor II
B) Both I and II
C) II only
D) I only
D) I only
Statement II is incorrect because cultural humility also involves a lifelong self-evaluation in which planners critically consider their own beliefs as well as those of their clients.
125
Which of these statements regarding people who have a kinesthetic learning style is CORRECT?
A) They tend to respond to graphs, charts, pictures, and text.
B) They prefer their goals and objectives to be presented as a to-do-list in bullet form.
C) They retain information by hearing or speaking.
D) They express themselves through facial expressions.
B) They prefer their goals and objectives to be presented as a to-do-list in bullet form.
Individuals who prefer goals and objectives to be presented in bullet form exhibit a kinesthetic learning style. People who retain information by hearing or speaking have an auditory learning style. Visual learners express themselves through facial expressions and respond well to graphs, charts, pictures, and text.
126
A client's assessment of the magnitude of the risks being traded off is known as
A) risk capacity.
B) risk tolerance.
C) risk perception.
D) emotional intelligence.
C) risk perception.
A client's assessment of the magnitude of the risks being traded off is known as risk perception. Risk tolerance refers to the tradeoffs clients are willing to make between potential risks and rewards. Risk capacity is the degree to which a client's financial resources can cushion risks. Emotional intelligence is the ability to recognize emotional expressions in oneself and the client and to select socially appropriate responses to both the circumstances and the client's emotions.
127
All of these statements regarding client psychology are CORRECT except
A) beliefs are a type of attitude because they reveal a person’s understanding of some aspect of his life.
B) a planner should recognize his own attitudes, values, biases, and behaviors, and be certain they do not impact recommendations made to clients.
C) a client’s profile is largely influenced by context, which includes past history or any conditions that presently exist.
D) a client’s context represents what he believes to be right.
D) a client’s context represents what he believes to be right.
A client's strong attitudes and beliefs are considered values and represent what the client believes to be right. All of the other statements are correct.
128
Max is meeting with his clients, Steve and Anne, to define their goals. Steve tells Max one of his goals is purchasing a boat in two years, and Anne rolls her eyes. What is the best action for Max to take next?
A) Recommend how Steve and Anne can pay for the boat.
B) Get more details regarding the purchase of the boat.
C) Ask Steve and Anne if they have any other goals.
D) Ask Anne if the boat is a mutually agreed-upon goal.
D) Ask Anne if the boat is a mutually agreed-upon goal.
Anne's body language (rolling her eyes) may express that she does not agree with this goal. Therefore, Max should clarify whether or not she is on board with Steve's idea. If Anne is agreeable, Max should then get more details regarding the purchase of the boat. Max should not move on to other goals before Steve and Anne are in agreement regarding this particular one.
Lastly, this is not the time to make recommendations without comprehensive information.
129
Which of these statements regarding the forms of representativeness is CORRECT?
I. Sample-size neglect makes the initial classification based on an overly small and potentially unrealistic sample of data.
II. Base rate neglect occurs when a stock is classified as a growth stock even though new information asserts this may no longer be the case.
A) II only
B) Neither I nor II
C) Both I and II
D) I only
C) Both I and II
To avoid sample-size neglect, sample-size neglect classifications should be based on adequate, realistic data samples. Base-rate neglect occurs when the base rate (probability) of the initial classification is not adequately considered. Essentially, the classification is taken as being 100% correct with no consideration that it could be wrong.
130
A client is presented with two equal investment opportunities. The first is stated in terms of potential gains, and the second is stated in terms of potential losses. Without having any additional information, the client selects the first investment. The client's decision reflects
A) anchoring.
B) framing bias.
C) loss aversion theory.
D) herding.
C) loss aversion theory.
The client's decision reflects the loss aversion theory, which states that people make decisions based on perceived gains rather than perceived losses. Herding occurs when a person follows the actions of a larger group, whether rational or not. Anchoring is making irrational decisions based on information that should have no influence on the decision at hand. Framing bias states that people are given a frame of reference, a set of beliefs or values, which they use to interpret facts or conditions as they make decisions.
131
Which of the following statements regarding the economic and resource approach to financial counseling is CORRECT?
I. Clients are assumed to be rational.
II. The focus is on obtaining and analyzing quantitative data, such as cash flow, assets, and liabilities.
III. In this approach, the client is the agent of change.
IV. Individuals will change to the most favorable behavior if given the appropriate counseling.
A) I, II, III, and IV
B) I and IV
C) II and IV
D) I, II, and IV
D) I, II, and IV
Using the economic and resource approach, clients are assumed to be rational and will change to the most favorable behavior if given the appropriate counseling. In this approach, the financial planner, not the client, is the agent of change. The focus is on obtaining and analyzing quantitative data, such as cash flow, assets, and liabilities.
132
Which of these questions a financial planner might ask a client are open-ended?
I. Do you have disability insurance coverage?
II. How do you feel about investing in the stock market?
III. Do you have a car payment?
IV. How are your job prospects for the future?
A) I, II, and III
B) II and IV
C) I and III
D) III only
B) II and IV
These are open-ended questions because they require clients to answer in their own words. Statements I and III are incorrect; these are closed-ended questions because they only require a "yes" or "no" answer.
133
Which of these statements regarding financial conflict is CORRECT?
A) Although it is important to notice nonverbal behaviors, it is more important to pay attention to spoken words.
B) To decrease conflict between parents and the adult children they support, it is prudent to have general conversations regarding expectations for each party.
C) Because married partners with dissimilar risk tolerance levels can present challenges during investment planning, there must be open and honest discussion between them regarding how joint funds should be invested.
D) To identify potential financial conflict, financial planners should place more emphasis on what client partners discuss than how they discuss it.
C) Because married partners with dissimilar risk tolerance levels can present challenges during investment planning, there must be open and honest discussion between them regarding how joint funds should be invested.
Because married partners with dissimilar risk tolerance levels can present challenges during investment planning, there must be open and honest discussion between them, facilitated by the planner, regarding how joint funds should be invested. To identify potential financial conflict, financial planners should give equal importance to what partners say and how they say it. Nonverbal behaviors, which are important to notice, are equally important as the spoken word. To lessen conflict between parents and adult children they support, it is prudent to establish detailed guidelines with the adult children, preferably in a written agreement with detailed terms.
134
Jason is meeting with Christine, who was recently referred to him by a friend. Which of these strategies might Howard use in a meeting with Christine to foster good communication?
I. Adopting the client's body language
II. Imitating the client's word use, tone of voice, and communication method
III. Asking as many questions as possible that require only a "yes" or "no" answer
IV. Paying full attention to what the client is saying and responding by paraphrasing the client's comments
A) III and IV
B) I, III, and IV
C) I, II, and IV
D) II only
C) I, II, and IV
Statements I (physical mirroring), II (verbal mirroring), and IV (active listening) are reliable techniques for establishing honesty and trust in interactions with clients. Statement III (asking closed-ended questions) should be avoided whenever possible in favor of asking open-ended questions.
135
During his initial interview with a financial planner, Sam explains the tradeoffs he is willing to make between potential risks and rewards. These tradeoffs illustrate Sam's
A) loss aversion.
B) risk capacity.
C) risk perception.
D) risk tolerance.
D) risk tolerance.
Risk tolerance refers to the tradeoffs people are willing to make between potential risks and rewards. Risk perception refers to a person's assessment of the magnitude of the risks being traded off. Risk capacity is the degree to which a person's financial resources can cushion risks. Loss aversion theory states that people value gains and losses differently and make decisions based on perceived gains rather than perceived losses.
136
Justin and Maddie have asked you to provide them with a comprehensive financial plan. During your initial meeting, you asked several questions to understand their feelings, goals, and objectives. Based on this discussion, you believe a consultative approach should be used that specifically identifies their strengths and weaknesses, among other factors. Which of these techniques is most closely aligned with your financial counseling approach in this case?
A) Classical economics approach
B) Strategic management approach
C) Cognitive-behavioral approach
D) Economic and resource approach
B) Strategic management approach
A SWOT analysis identifies a client's strengths, weaknesses, opportunities, and threats. This analysis is completed early in the planning process. With this approach, the planner assumes the role of consultant.
137
Which of these statements regarding emotional biases is CORRECT?
I. They are more difficult to overcome than cognitive biases.
II. They are a result of feelings, intuition, or impulse and are not related to conscious thought.
A) II only
B) Both I and II
C) Neither I nor II
D) I only
B) Both I and II
Emotional biases are not related to conscious thought and stem from feelings, impulses, or intuition. As such, they are more difficult to overcome and may have to be accommodated.
138
All of these signal financial conflict among partners during meetings except
A) partners sitting far from one another.
B) no eye contact between partners.
C) one partner speaking more frequently than the other.
D) one partner pausing longer than the other before answering questions directed at them.
D) one partner pausing longer than the other before answering questions directed at them.
One partner pausing longer than the other before answering questions directed at them does not necessarily indicate financial conflict. One partner may simply take more time than the other to gather their thoughts and process information. All of the other actions signal financial conflict.
139
Which of these statements regarding behavioral finance is CORRECT?
I. Behavioral finance attempts to understand why people often act irrationally when making financial decisions.
II. Concepts used in behavioral finance include herding and confirmation bias.
A) Both I and II
B) I only
C) II only
D) Neither I nor II
A) Both I and II
140
Financial manipulation takes several forms. Which of these types of financial manipulation is correctly described?
I. Financial abuse is controlling an individual's ability to use, obtain, or possess financial resources.
II. Financial enmeshment most often involves one partner being more financially literate than the other.
A) Neither I nor II
B) II only
C) I only
D) Both I and II
C) I only
Financial enmeshment, or financial enabling, most often involves supporting an adult who should not need to dependent on the enabler. This typically occurs in a parent-child relationship, but can also be the case between siblings, other relatives, or friends who often see their own financial wellbeing decline when they provide the financial support. Financial control often involves one partner being more financially literate than the other.
141
The ability to meet current and future financial obligations and the financial freedom of choice to maintain a desired lifestyle is known as
A) interior finance.
B) financial well-being.
C) integrated financial planning.
D) financial therapy.
B) financial well-being.
Integrated financial planning involves exterior finance (relating to clients' traditional financial matters) and interior finance (clients' emotional relationships with money). Financial therapy is a process informed by both therapeutic and financial expertise that helps clients think, feel and behave differently with money to improve overall well-being. It addresses financial well-being at a deep level.
142
Which of these is an action planners can take to address the goal incongruence that results from conflicting goals or indecision when establishing them?
A) Planners can share their own experiences, beliefs, and emotions to help partners agree on more common goals.
B) Planners should stress the importance of each partner maintaining their own individual perspective, even if it does not help partners from moving toward more common goals.
C) Planners should help partners understand why they disagree with one another.
D) Although goal incongruence is not common, planners should advise partners that planners can help them work toward more common goals if it does occur.
C) Planners should help partners understand why they disagree with one another.
Through partners sharing the experiences, beliefs, and emotions that are driving the their disagreement, they can explore why they disagree with each other. A mutual understanding of what is driving the goal incongruence will help each partner see the other's perspective which, in turn, could lead to agreement. Goal incongruence is common; nearly every couple experiences it when goals are established and decisions are made.
143
Which of these statements regarding the field of behavioral finance is CORRECT?
I. Two concepts common to behavioral finance are anchoring and overconfidence.
II. Behavioral finance attempts to explain why people sometimes make rational decisions regarding their finances.
A) Both I and II
B) II only
C) Neither I nor II
D) I only
D) I only
Behavioral finance attempts to explain why people sometimes make irrational decisions regarding their finances. This helps planners better understand their clients so they can best advise them. Statement I is correct.
144
Ed has accumulated $10,000 in a savings account over the last few years and has earmarked that money as a down payment on a new boat. His air conditioner breaks and requires $5,000 in repairs. Ed is reluctant to spend the money in his savings account to make the repairs because he wants to use that money for the boat down payment. Instead, he puts the $5,000 repair bill on his credit card at an annual interest rate of 23%. This is an example of which of these behaviors?
A) Loss aversion
B) Mental accounting
C) Confirmation bias
D) Herding
B) Mental accounting
This is an example of mental accounting because Ed's irrational financial decision resulted from mentally putting his money into separate "accounts" based on the function of those accounts. Loss aversion occurs when a person makes a bad decision because he fears losses more than he values gains. Herding occurs when a person follows the actions of a larger group, whether rational or not. Confirmation bias means people tend to pay attention to information that supports their preconceived opinions while disregarding accurate, unsupported information.
145
Which of these statements regarding the classical economics approach to financial counseling are CORRECT?
I. A choice among alternatives is based on objectively defined cost-benefit and risk-returns.
II. It is based on the belief that increasing financial resources or reducing financial expenditures results in improved financial results.
A) Neither I nor II
B) I only
C) II only
D) Both I and II
D) Both I and II
In this approach, clients choose among alternatives based on objectively defined cost-benefit and risk-return tradeoffs. The belief in this approach is that increasing financial resources or reducing financial expenditures results in improved financial results.
146
One of your clients, Phil, has a tendency to follow the actions of a larger group of people when making financial decisions, whether those actions are rational or not. Phil's behavior is an example of
A) confirmation bias.
B) overconfidence.
C) herding.
D) anchoring.
C) herding.
Confirmation bias is the tendency to pay attention to information that supports one's preconceived opinions, while disregarding accurate, supported information. Overconfidence occurs when an investor considers their abilities to be much better than they actually are. Anchoring occurs when a person makes an irrational decision based on information that should have no influence on the decision.
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Which of the following statements regarding interpersonal communication between financial planners and their clients are CORRECT?
I. Mirroring is accomplished by imitating the client's body language or verbal style.
II. Body language can impact how clients receive and interpret messages more than any other type of communication.
III. Emotional intelligence includes the ability to recognize emotional expressions and select socially appropriate responses.
IV. Proper use of these communication skills helps develop a relationship of honesty and trust between financial planners and their clients.
A) I and IV
B) III and IV
C) I, II, III, and IV
D) I, II, and III
C) I, II, III, and IV
All the statements regarding interpersonal communication are correct.
