Psychology

Question 1

Heuristics

Answer 1

The act of enabling people to learn things on their own (combining baking soda and vinegar together to make a volcanos in science class)

In regards to finance, most people learn everything on their own and develop incorrect heuristics (cognitive bias)

Question 2

January Effect

Answer 2

Calendar year related market anomaly where prices increase in the month of January
- main characteristic is buying stock before the end of the year and selling them in January

Question 3

Anchoring

Answer 3

Tendency for investors to become attached to a specific price as the fair value of the holding
- holding on to a stock that you bought for $100 when it drops and waiting for it to get back to that price
- Force yourself to evaluate the investment like it was a new investment
- Also could be attaching to one fact

Question 4

Attachment Bias

Answer 4

Holding onto investment for emotional reasons (attached to something)
- Grandfather left the stock

Question 5

Availability Bias

Answer 5

Making decisions based on the information that is most readily available or easy to recall but not relevant to the current choice being made
- Not buying a car company stock due to them lying about stock and this is the first thing that comes up online

Question 6

Cognitive Dissonance

Answer 6

The discord felt when investors make decisions contrary to their actual beliefs
- conservative investor puts all money in Crypto and then says they are aggressive investor

Question 7

Confirmation Bias

Answer 7

Accept information that confirms our preconceived position or opinion and disregard information that conflicts

Question 8

Diversification Errors

Answer 8

Investors tend to diversify evenly across any options that are given to them

Question 9

Endowment Bias

Answer 9

Place more value on items you currently have - could be caused by emotional attachment
- Think you can sell stuff you have for more

Question 10

Familiarity Bias

Answer 10

Customer buys based on their experience…. Buying apple stock because you own an iPhone

Question 11

Fear of Regret

Answer 11

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

Question 12

Flat Rate Bias

Answer 12

Tendency for people to prefer fixed payment streams versus variable ones

Question 13

Gamblers Fallacy

Answer 13

Onset of certain event is less likely to happen after a series of events
- Picking red after seeing a lot of blacks on roulette

Question 14

Herd Behavior

Answer 14

Tendency to mimic actions of a larger group or the opposite

Question 15

Hindsight Bias

Answer 15

20/20 vision we think we have after an event thinking we understand it when we really dont
- Claiming to have known about the tech bubble

Question 16

Loss Aversion and Risk Taking

Answer 16

Losses hurt more then the feeling you get when you get a gain
- having 50 and loosing 25 hurts more than just getting 25

Question 17

Mental Accounting

Answer 17

Looking at sums of money differently - all money is the same

Question 18

Overconfidence

Answer 18

Tendency to place to much emphasis on ones own abilities - often works hand and hand with confirmation bias

Question 19

Recency Bias

Answer 19

Tend to make decisions on the most recent information

Question 20

Representative Bias

Answer 20

Tendency to use stereotypes across situations that appear similar but are not

Question 21

Salience Bias

Answer 21

Place more emphasis on information that is more emotionally stimulating or vivid

Question 22

Self Affirmation Bias

Answer 22

When something goes right it’s because of you, but if something goes wrong its due to someone else

Question 23

Status Quo Bias

Answer 23

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

Question 24

Sunk Cost Fallacy

Answer 24

Tendency to keep an investment due to the resources committed to it

Question 25

Paradox of Choice

Answer 25

More people will pick the default option as the amount of choices increase (less decisions when they have more choices)

Question 26

Solving Biases: System 1 & System 2

Answer 26

System 1
- Unconscious Response
- Reaction
- Intuitive
- Instinctual
- Emotional

System 2
- Conscious Choice
- Decision
- Cognitive
- Educated
- Rational

Question 27

Solving Biases: Modifying the Decision Maker

Answer 27

1: Move decision makers from system 1 to system 2. Reduced bias to help make their decisions more rational.

• Typically educating clients
• Try to improve the odds of this move; dont force it

Things to keep in mind
- Given them time
- Have a planned approach
- Teach the importance of taking a long term view
- Use models, tools, graphs, plain English to make point

Question 28

Sources of Money Conflict

Answer 28

Transparency between couples is important; view a couple as one client

Potentially involve a professional

Question 29

Workaholism

Answer 29

Workaholics feel better working; could lead to problems in personal life

Question 30

Compulsive Buying Disorder

Answer 30

Impulse control buying (irresistible impulse); often coupled with eating disorder or drug abuse

Question 31

Underspending

Answer 31

Underspending can cause negative financial and personal issue. Cause extreme anxiety about spending.

Question 32

Financial Enmeshment

Answer 32

Putting a kid in the middle of an adult financial conversation; divorce.
- could lead to bad behaviors for children

Question 33

Financial Denial / Vow of Property

Answer 33

Denial: refusing to take action

Vow of Property: thinking doing good for other and they will be taken care of without a plan

Question 34

Role of Counseling in Financial Planning

Answer 34

Exterior (quantitative): balance sheet creation, cash flow statement, running projections for retirement, etc.

Interior (qualitative): Internal - focuses on goals, dreams, fears, beliefs