Behavioral Finance and Client Psychology

Vocabulary flashcards covering core concepts of behavioral finance, risk components, learning styles, client context, and specific cognitive and emotional biases discussed in the lecture.

Behavioral Finance

A field of study that relates behavioral and cognitive psychology to financial planning and economics to explain why people make irrational decisions.

Heuristics

Mental shortcuts or rules of thumb developed from System 1 processes that help individuals navigate decisions without having to consciously evaluate every encounter.

Biases

Thinking errors that develop from heuristics and can impact how an individual makes decisions.

Herding

A bias that involves following the crowd, which can contribute to the formation of economic bubbles.

Risk Tolerance

The trade-off a client determines between risk and rewards given some probability of negative outcomes, influencing their willingness to take on a specific risk.

Risk Preference

A personal trait reflecting how an individual feels about a specific risk, leading them to prefer certain risks over others.

Risk Perception

A subjective judgment where a client makes a decision based on how they personally perceive a particular risk.

Risk Capacity

The degree to which a client's financial resources can absorb or mitigate financial risks and losses.

Risk Literacy

A client's ability to understand and act upon information regarding financial risks.

Visual Learning Style

A learning style where individuals learn by looking at things and respond well to visual objects such as graphs, charts, and pictures.

Auditory Learning Style

A learning style where individuals learn primarily through hearing and retain information by speaking it aloud or listening to explanations.

Kinesthetic Learning Style

A learning style where individuals learn by doing, often express themselves through body language, and benefit from action-oriented plans with bullet points.

Attitudes

Expressions that reflect an individual's opinions, values, and wants.

Beliefs

A type of attitude that reveals a deep understanding of certain aspects of an individual's life.

Values

Attitudes and beliefs toward which an individual feels strongly.

Context

The background and circumstances shaping a client's development and worldview, including family of origin, generational cohorts, culture, religion, and life cycle stage.

Cognitive Biases

Decision-making errors or information processing mistakes based on faulty reasoning, statistical misunderstandings, or concepts that may not apply outside their original context.

Emotional Biases

Biases originating from feelings, impulses, or intuition rather than conscious thought, which are deeply ingrained and often require accommodation rather than direct correction.

Illusion of Control Bias

A cognitive bias in which people believe they can control or influence outcomes when, in fact, they cannot.

Money Illusion

A cognitive bias involving a misunderstanding of rates of return, particularly when distinguishing between nominal rates and real, inflation-adjusted rates.

Conservatism Bias

A cognitive bias where an individual forms an initial rational view but fails to update or revise it when new information becomes available.

Hindsight Bias

A cognitive error of selective memory where an individual remembers past actions that turned out well and forgets those that failed.

Confirmation Bias

A cognitive bias where an individual seeks out information that supports preexisting opinions while avoiding or ignoring evidence that disconfirms them.

Representativeness Bias

A cognitive error where an individual evaluates a present choice by recalling a past experience and incorrectly assuming that one thing is like another.

Mental Accounting

A cognitive bias, also known as the money jar mentality, where an individual separates money into different silos or accounts and treats the funds as nonfungible.

Cognitive Dissonance

The mental discomfort experienced when new information conflicts with preexisting perspectives or understandings.

Self-Attribution Bias

A cognitive bias used to avoid cognitive dissonance, where an individual takes credit for positive outcomes while blaming external factors or others for negative outcomes.

Anchoring

A cognitive bias (also called anchoring and adjustment) where an individual relies too heavily on an initial piece of information, such as a specific valuation number, and fails to adjust to market changes.

Outcome Bias

A cognitive bias where an individual chooses a course of action based primarily on the outcome of a prior event rather than the quality of the current decision.

Framing Bias

A cognitive bias where a person's decision is influenced by how information is presented, such as responding more favorably to positive framing than negative framing.

Recency Bias

A cognitive bias where an individual overweights recent events and information while underweighting data that is further in the past.

Availability Bias

A cognitive bias where an individual places excessive weight on information that is easy to recall and underweights information that is harder to retrieve.

Loss Aversion

An emotional bias where the psychological pain of experiencing a financial loss is felt more intensely than the pleasure derived from an equivalent gain.

Overconfidence

An emotional bias where an individual believes they can control random events, leading them to claim credit for positive results and blame external factors for negative ones.

Self-Control Bias

An emotional bias where an individual lacks the discipline to pursue long-term goals and instead favors immediate gratification.

Status Quo Bias

An emotional bias characterized by a reluctance to alter one's current behavior or holdings, even when superior alternatives exist.

Endowment Bias

An emotional bias (also known as the endowment effect) where an individual overvalues an asset merely or strictly because they own it.

Regret Aversion Bias

An emotional bias where an individual refuses to take action out of fear that their decision will turn out to be wrong.

Affinity Bias

An emotional bias where decision-making is steered by a preference for things with which an individual identifies on an emotional level.