Behavioural Finance Flashcards
(12 cards)
What does behavioural finance focus on?
The irrationality exhibited by investors
driven by psychology, emotions and biases
Why should investment managers care about behavioural finance?
Better understand client decisions
To better design services to meet client needs (e.g. avoid framing)
What is a heuristic?
A rule of thumb or shortcut an individual uses when processing information and is time / mentally constrained
shortcuts to thinking
Give 5 examples of Heuristics
1) Use of information
2) Intertia
3) Representativeness
4) Gambler’s Fallacy
5) Overconfidence
6) Anchoring
When does the use of heuristics becomes more likely?
When an individual is faced with:
1) More choices
2) Complex choices
3) Pressure around making a choice
how can an advisor reduce the use of heuristics
Do not overload with information + do not give overly complex info
Sometimes - limited choices are the best to allow a client to select what is suitable for them
What does prospect theory say?
Individual’s weigh losses more heavily than equal gains
pain of a loss is 2x the joy felt from an equally sized gain
What does prospect theory lead to?
1) Break even effect
2) The disposition effect
How can an advisor help a client to overcome overconfidence bias?
Review investment decisions with honesty to identify mistakes
How can an advisor help a client to overcome loss aversion?
Help a client understand value of future investments in order to stop early selling
How can an advisor help a client to overcome the Gambler’s fallacy
Explain the independence of market events
could give examples like a roulette wheel to help understand
How can an advisor help a client to overcome inertia / status quo
1) Regular Reviews
2) Reminders / Nudges for check-ins
3) Automatic rebalancing (e.g. lifestyling options)
