Psychology Of Financial Planning Psychology of financial planning Flashcards
Client actions are organized into what two groups?
Cognitive errors and emotional biases
What are cognitive errors?
Due to faulty reasoning
Lack of understanding of proper statistical analysis techniques, information, processing mistakes, memory errors
Often can be corrected or mitigated with better training or information
What are the 13 cognitive errors?
- Illusion of control bias
- Conservatism bias
- Hindsight bias.
- Confirmation bias.
- Representativeness bias
- Mental accounting.
- Self attribution bias.
- Adjustment.
- Outcome bias.
- Anchoring.
- Framing bias.
- Recency bias.
- Herding
What is the illusion of control bias?
Think they can influence outcomes when they cannot
What is conservatism bias?
Initially assume a rational view, but failed to change that view as new information becomes available
Do not adjust to new information
What is hindsight bias?
Selective memory of past events, actions
Tend to remember their correct views forget the errors
What is confirmation bias?
Market participants look for new information to support an existing view
Become overly attached to some investments, only bring up information favorable to the holding
What is representativeness?
Believe the past will persist
New information is classified based on previous experiences
What is mental accounting?
Also known as money jar mentality
Tendency of individuals to put their money into separate accounts, based on the function of these accounts
What is self attribution bias?
Ego defense mechanism, having to admit making a mistake
What is anchoring?
Irrational decisions, based on information that should have no influence on the decisions at hand
Risky when people know a little about the product being purchased, or service, being delivered, or investment being made
What is adjustment?
Clinging on to an initial estimate, not adjusting for new information
What is outcome bias?
Tendency for individuals to take a course of action based on the outcomes of prior events
What is framing bias?
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
What is recency bias?
Recent information is given more important because it is most vividly remembered
What is herding?
Investors trade in the same direction for the same securities and possibly trade contrary to the information they have available
What are emotional biases?
Not related to conscious thought stand from feelings, impulses, or intuition
More difficult to overcome may have to be accommodated
What are emotional biases?
Not related to conscious thought stand from feelings, impulses, or intuition
More difficult to overcome may have to be accommodated
What are the eight emotional bias theories?
- Prospect theory.
- Loss aversion theory
- Over confidence.
- Self control bias
- Status quo bias.
- Endowment bias.
- Regret aversion bias
- Affinity bias.
What is prospect theory?
Having a loss is much more than valuing gains
Often choose the smaller of two potential gains if it avoids a sure loss
What is loss aversion theory?
Involves clients, valuing gains and losses differently
Makes decisions based on perceive Gaines, rather than perceived losses
What is overconfidence?
Believe that they can control random events, merely by acquiring more knowledge, and consider their abilities to be much better than they are
What is self control bias?
Lack self discipline and favor, immediate gratification over long-term goals
What is status quo bias?
Comfort with an existing situation leads to an unwillingness to make changes