Psychology for CFP

Question 1

Cognitive Bias (Definition)

Answer 1

Errors made by individuals in their decision-making process, when they lack the ability to process the available information, or do not have access to the necessary information to make rational decisions.

Question 2

Heuristics (Definition)

Answer 2

Mental shortcuts that people use to simplify their judgment and choice when trying to find a solution to a problem.

Question 3

Availability Bias (Definition)

Answer 3

The predisposition to make decisions based on information that can be easily recalled but may be irrelevant to the specific decision being made.

Question 4

Salience Bias (Definition)

Answer 4

The tendency to assign greater weight to items that are more vivid or emotional when making decisions.

Question 5

Recency Bias (Definition)

Answer 5

The bias induced as a result of making decisions based on information that is prominent because it is being recalled from a recent experience.

Question 6

Persuasion Bias (Definition)

Answer 6

The bias based on information that is repeated frequently.

Question 7

Familiarity Bias (Definition)

Answer 7

The predisposition to use the most prominent number as a reference point when estimating a value in the presence of substantial uncertainty.

Question 8

Mental Accounting (Definition)

Answer 8

The tendency to compartmentalize cash flows or assets and treat these accounts separately.

Question 9

Representativeness Bias (Definition)

Answer 9

People’s tendency to use stereotypes.

Question 10

Law of Small Numbers (Definition)

Answer 10

When people tend to make a decision based on a limited set of data points.

Question 11

Gambler’s Fallacy (Definition)

Answer 11

When people assign a 50-50 probability to an event that had a limited number of draws.

Question 12

Status Quo Bias (Definition)

Answer 12

People’s predisposition to no change when presented with a choice.

Question 13

Cognitive Bias (Example)

Answer 13

An investor is presented with a large amount of information about a stock, but they make their decision based on the most prominent feature, such as the company’s brand or recent news, rather than considering all the information available.

Question 14

Heuristics (Example)

Answer 14

An investor is trying to decide which stock to invest in. Instead of analyzing the company’s financials and performance, they might use a heuristic such as always investing in companies in a certain industry, even if it is not the best investment opportunity.

Question 15

Availability Bias (Example)

Answer 15

An investor is trying to decide whether to invest in a certain stock. They might base their decision on a recent news article they read about the company, even if the information in the article is not relevant to the stock’s performance.

Question 16

Salience Bias (Example)

Answer 16

An investor is trying to decide which stock to invest in. They might assign greater weight to the company’s recent news or events, rather than considering more important factors such as the company’s financials or long-term performance.

Question 17

Recency Bias (Example)

Answer 17

An investor is trying to decide which stock to invest in. They might base their decision on the stock’s recent performance, even if that performance is not representative of the stock’s long-term performance.

Question 18

Persuasion Bias (Example)

Answer 18

An investor is trying to decide which stock to invest in. They might base their decision on information that is repeated frequently in the media, even if the information is not accurate or relevant to the stock’s performance.

Question 19

Familiarity Bias (Example)

Answer 19

An investor is trying to decide which stock to invest in. They might choose a stock from a well-known company, even if there are other stocks with better performance from less familiar companies.

Question 20

Anchoring (Example)

Answer 20

An investor is trying to estimate the value of a stock. They might use the first price they see, such as the current stock price, as a reference point, even if it is not an accurate representation of the stock’s true value.

Question 21

Mental Accounting (Example)

Answer 21

An investor receives a bonus at work. Instead of considering the bonus as part of their overall investment portfolio, they might treat it as a separate account and invest it in a high-risk stock, rather than diversifying their portfolio.

Question 22

Representativeness Bias (Example)

Answer 22

An investor is trying to decide which stock to invest in. They might base their decision on the stock’s recent performance, assuming that it is representative of its long-term performance, even if it is not.

Question 23

Law of Small Numbers (Example)

Answer 23

An investor is trying to decide whether to invest in a certain stock. They might base their decision on the stock’s performance over a short period of time, such as a week, even if that performance is not representative of its long-term performance.

Question 24

Gambler’s Fallacy (Example)

Answer 24

An investor is trying to decide whether to invest in a certain stock. They might believe that if the stock has performed poorly several times in a row, it is more likely to perform well in the future, even though past performance is not indicative of future results.

Question 25

Status Quo Bias (Example)

Answer 25

An investor is trying to decide whether to switch to a new investment strategy. They might prefer to stick with their current strategy, even if the new strategy offers better returns or lower risk, simply because they are used to their current strategy.

Question 26

Endowment Effect (Definition)

Answer 26

Endowment effect is people’s tendency to overvalue what they own.

Question 27

Confirmation Bias (Definition)

Answer 27

Confirmation bias is the predisposition to search for information that supports an individual’s opinion.

Question 28

Flat Rate Bias (Definition)

Answer 28

Flat rate bias is the tendency of people to choose a fixed payment or income stream over a variable payment or income stream option.

Question 29

Sunk Cost Fallacy (Definition)

Answer 29

Sunk cost fallacy is a cognitive error where people tend to hold on to their unsuccessful loss-making investments or businesses because they have previously committed resources to the specific investment or business.

Question 30

Cognitive Dissonance (Definition)

Answer 30

Cognitive dissonance is the tension that arises in a person’s mind when they simultaneously have two conflicting thoughts about making a certain decision.

Question 31

Endowment Effect (Example)

Answer 31

A person may be reluctant to sell an item that they own, even if it is not being used or is outdated, because they assign a higher value to it simply because they own it.

Question 32

Confirmation Bias (Example)

Answer 32

A person may have made up their mind to pursue a certain course of action and will selectively search for information that supports their decision, while ignoring or dismissing information that contradicts their decision.

Question 33

Flat Rate Bias (Example)

Answer 33

A person may choose a fixed-rate mortgage over a variable-rate mortgage because they prefer the certainty of the fixed payment, even if the variable-rate mortgage may be cheaper in the long run.

Question 34

Sunk Cost Fallacy (Example)

Answer 34

A person may continue to invest time and money into a failing project because they have already committed significant resources to it, even though it would be more rational to cut their losses and invest in a more profitable opportunity.

Question 35

Cognitive Dissonance (Example)

Answer 35

A person may experience cognitive dissonance when they make an impulsive decision that goes against their usual values or beliefs. In such situations, the person may change their viewpoint to justify their actions and reduce the discomfort caused by the dissonance. For instance, when a person makes an impulse purchase decision on an expensive gadget or a collectible item, which may be contrary to their otherwise frugal attitudes and spending habits, they would simply change their views and offer justifications that would support their spending decision.