Psychology Flashcards
Heuristics
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)
January Effect
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
Anchoring
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
Attachment Bias
Holding onto investment for emotional reasons (attached to something)
- Grandfather left the stock
Availability Bias
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
Cognitive Dissonance
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
Confirmation Bias
Accept information that confirms our preconceived position or opinion and disregard information that conflicts
Diversification Errors
Investors tend to diversify evenly across any options that are given to them
Endowment Bias
Place more value on items you currently have - could be caused by emotional attachment
- Think you can sell stuff you have for more
Familiarity Bias
Customer buys based on their experience…. Buying apple stock because you own an iPhone
Fear of Regret
Tendency to take no action rather than risk making the wrong one
Flat Rate Bias
Tendency for people to prefer fixed payment streams versus variable ones
Gamblers Fallacy
Onset of certain event is less likely to happen after a series of events
- Picking red after seeing a lot of blacks on roulette
Herd Behavior
Tendency to mimic actions of a larger group or the opposite
Hindsight Bias
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
Loss Aversion and Risk Taking
Losses hurt more then the feeling you get when you get a gain
- having 50 and loosing 25 hurts more than just getting 25
Mental Accounting
Looking at sums of money differently - all money is the same
Overconfidence
Tendency to place to much emphasis on ones own abilities - often works hand and hand with confirmation bias
Recency Bias
Tend to make decisions on the most recent information
Representative Bias
Tendency to use stereotypes across situations that appear similar but are not
Salience Bias
Place more emphasis on information that is more emotionally stimulating or vivid
Self Affirmation Bias
When something goes right it’s because of you, but if something goes wrong its due to someone else
Status Quo Bias
Tendency of investors to do nothing when action is actually called for
Sunk Cost Fallacy
Tendency to keep an investment due to the resources committed to it
Paradox of Choice
More people will pick the default option as the amount of choices increase (less decisions when they have more choices)
Solving Biases: System 1 & System 2
System 1
- Unconscious Response
- Reaction
- Intuitive
- Instinctual
- Emotional
System 2
- Conscious Choice
- Decision
- Cognitive
- Educated
- Rational
Solving Biases: Modifying the Decision Maker
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
Sources of Money Conflict
Transparency between couples is important; view a couple as one client
Potentially involve a professional
Workaholism
Workaholics feel better working; could lead to problems in personal life
Compulsive Buying Disorder
Impulse control buying (irresistible impulse); often coupled with eating disorder or drug abuse
Underspending
Underspending can cause negative financial and personal issue. Cause extreme anxiety about spending.
Financial Enmeshment
Putting a kid in the middle of an adult financial conversation; divorce.
- could lead to bad behaviors for children
Financial Denial / Vow of Property
Denial: refusing to take action
Vow of Property: thinking doing good for other and they will be taken care of without a plan
Role of Counseling in Financial Planning
Exterior (quantitative): balance sheet creation, cash flow statement, running projections for retirement, etc.
Interior (qualitative): Internal - focuses on goals, dreams, fears, beliefs
