Understanding a Client's Risk Profile Flashcards
(21 cards)
REPRESENTATIVENESS
In the investment realm, a client may be presented with an investment opportunity that contains some elements
that are representative of a good investment.
ANCHORING AND ADJUSTMENT
A client is asked whether the Dow Jones Industrial Average will be greater or less than 30,000 next year.
Obviously, the answer will be either above or below 30,000. If the client was then asked to guess an absolute
value of the index next year, the estimate would probably fall somewhere near 30,000, because it is likely subject
to anchoring by the previous response.
AVAILABILITY
Availability bias is a heuristic that allows people to estimate the probability of an outcome based on how prevalent
or familiar it appears in their lives
Mutual fund advertising is a good example of availability bias. Investors who see a certain company’s
advertisements on a frequent basis may believe it is a good mutual fund company; however, it is possible that a
company that does not advertise is better.
SELF-ATTRIBUTION
Students
doing well on an exam, for example, might credit their own intelligence or work ethic, while those failing might cite
unfair grading. Investors often incorrectly ascribe investment success to themselves, while investment failure is
usually someone else’s fault.
CONSERVATISM
Conservatism bias is a mental state in which people cling to a prior view or forecast, and do not acknowledge or
obtain new information that might change an existing view.
An investor receives bad news regarding a company’s earnings and this news contradicts an earnings estimate
issued in the previous month. Conservatism bias may cause the investor to underreact to the new information,
maintaining a belief in the previous, more optimistic estimate, rather than act on the updated information.
AMBIGUITY AVERSION
People avoid making an investment or taking risks when probability distributions seem uncertain to them, because
they hesitate in situations of ambiguity
MENTAL ACCOUNTING
Mental accounting causes investors to irrationally treat various sums of money differently based on where these sums are mentally categorized.
FRAMING
Framing bias is the tendency to respond to various situations differently, based on the context in which a choice is
presented (or framed).
Optimistically worded questions are more likely to be acted upon than
negatively worded ones. Likewise, optimistically worded answer choices are more likely to be selected than
pessimistically phrased alternatives. Framing contexts are often arbitrary and uncorrelated; therefore, they should
not impact an investor’s judgments. However, they often do.
ENDOWMENT
People who are subject to endowment bias place more value on an asset they hold property rights to than on
one they do not hold rights to
Psychologists have found that the minimum selling prices that people state tend to exceed the maximum
purchase prices they are willing to pay for the same good. Investors continue to hold securities they own rather than
disposing of them in favour of better investing opportunities
OPTIMISM
Investors tend to be overly optimistic about the markets, the economy, and the potential for positive performance
of their investments. Many overly optimistic investors believe that bad investment outcomes will not happen to
them, only to other people
LOSS AVERSION
Loss aversion can prevent people from unloading unprofitable investments, even when they see little to no prospect
of a turnaround. Some industry veterans have coined the term “get-even-itis” to describe this condition, whereby a
person waits too long for an investment to rebound following a loss.
REGRET AVERSION
People who are subject to regret aversion bias avoid making decisions because they fear, in hindsight, that whatever
they decide to do will result in a bad decision.
STATUS QUO
Status quo bias can cause investors to hold securities with which they feel familiar or emotionally fond. This
behaviour can compromise financial goals, however, because a subjective comfort level with a security may not
justify holding onto it despite poor performance.
IDEALIST VERSUS PRAGMATIST (I VS. P)
People who fall into the idealist end of the I vs. P spectrum overestimate their investing abilities, display excessive
optimism about the capital markets, and do not seek out information that contradicts their views
Pragmatists, on the other hand, display a realistic grasp of their own skills and limitations as investors. They are not
too overconfident about the capital markets and demonstrate a healthy dose of scepticism regarding their investing
abilities
Women are susceptible to
Women are susceptible to: Endowment bias (Emotional), Status quo bias (E), Representativeness bias (C), Regret aversion bias (E). Men are susceptible to: Overconfidence bias (Cognitive), Loss aversion bias (E), Availability bias (C). (more emotional biases)
Men are susceptible to
Availability, loss aversion, overconfidence (cognitive)
FRAMER VERSUS INTEGRATOR (F VS. N)
Framers tend to evaluate their investments individually and do not consider how each of them fits into an overall
portfolio plan. They are too rigid in their mental approach to analyzing problems. The framer’s portfolio is composed
of unique “pots” of money, rather than a combination of well-managed investments.
Integrators, on the other hand, are characterized by an ability to contemplate broader contexts and externalities.
They correctly view their portfolios as systems whose components can interact and balance one another out.
Integrators understand the correlations between various financial instruments, and structure their portfolios
accordingly.
REFLECTOR VERSUS REALIST (T VS. R)
Reflectors have difficulty living with the consequences of their decisions and taking action to rectify their behaviours.
They justify and rationalize incorrect actions and hesitate to own up to decisions that have not worked out beneficially.
They also suffer from decision paralysis because they dread the sensation of regret should they miscalculate
Realists, on the other hand, have less trouble coming to terms with the consequences of their choices. They do not
tend to scramble for excuses in order to justify incorrect actions, and they assume responsibility for their mistakes.
Since realists have an easier time than reflectors in making decisions under pressure, they do not experience
regret as acutely and, consequently, do not dread it ahead of time.
best practical allocation.
risk questionnaire + taking into account investor biases
handling biases
moderate cognitive, adapt to emotional
moderate for less wealthy, adapt to more wealthy
