Behavioral Finance Flashcards
(33 cards)
What is Heuristics
Heuristics are experiences and biases that can facilitate problem-solving and probability judgments.
Examples that employ heuristics in daily life include using trial and error, a rule of thumb, or an educated guess
What is Behavioral Finance
The study of how psychology affects finance.
Financial Infidelity
Financial infidelity happens when one partner, typically a spouse, lies to the other about debts, credit cards, keeps money in a secret account, hides purchases and otherwise hides or lies about money.
Anchoring
The tendency of investors to become attached to a specific price as the fair value of a holding
Attachment Bias
Holding onto an investment for emotional reasons rather than considering more practical applications for the inheritance.
Example: My grandfather left me this stock so I can never sell it.
Endowment Bias
The endowment effect describes an emotional bias that causes individuals to value an owned object higher, often irrationally, than its real-world market value. In reality, you might not even purchase the asset if you didn’t already own it.
Financial Enmeshment Bias
Financial enmeshment happens when the finances of parents and children are inappropriately commingled.
Cognitive Dissonance
The challenge of reconciling two opposing beliefs
Confirmation Bias
The natural human tendency to accept any information that confirms our preconceived position or opinion and to disregard any information that does not support that preconceived notion.
Diversification Errors
Investors tend to diversify evenly across whatever options are presented to them.
Fear of Regret
The tendency to take no action rather than risk making the wrong one.
Gambler’s Fallacy
An individual erroneously believes that the onset of a certain random event is likely to happen following an event or a series of events.
Herd Behavior
The tendency for individuals to mimic the actions of a larger group. Can also be described as Fear of Missing Out (FOMO).
Hindsight Bias
The 20/20 vision we have when looking at a past event and thinking we understand it, when in reality we may not.
Inappropriate Extrapolation
The tendency to look at recent events (or market performance) and assume that those events or conditions will continue indefinitely.
Analysis Paralysis (or Paralysis by Analysis)
This describes an individual/couple overanalyzing a situation and can cause decision making to become ‘paralyzed’, meaning that no solution or course of action is decided upon.
Loss Aversion and Risk Taking
While investors are risk averse when it comes to gains (they do not want to give them up), they are risk seekers when it comes to losses (they will take big risks to avoid realizing them).
Prospect Theory (Similar to Loss Aversion/Risk Taking)
It describes the different ways people evaluate losses and gains. The researchers Kahneman and Tversky found that losses have a much greater negative impact than a commensurate gain will have positive.
Mental Accounting
This entails looking at sums of money differently, depending on their source or the intended use.
Outcome Bias
The tendency to make a decision based on the desired outcome rather than on the probability of that outcome.
Overconfidence
This is the tendency to place too much emphasis on one’s own abilities. It often works hand in hand with confirmation bias.
Overreaction
Investors emotionally react towards new market information.
Over-Weighting the Recent Past
Investors like patterns, and recent past represents a nice, easy-to-find pattern that can become the basis for an investment decision.
Self-Affirmation Bias
The belief that when something goes right, it is because you were smart and made the right decision. If it does not work out, it is someone else’s fault or simply bad luck.
