KNOWLEDGE EXPECTED OF: Both CFP® Professionals and QAFPTM Professionals
Define a heuristic.
Explain the reasons why the brain uses heuristics in decision making.
Explain the potential impact that a heuristic may have on decision making.
Time spent making decision
Effort expended making decision
Appropriateness of decision
Define types of heuristics that the brain may use when making decisions, such as:
Anchoring and adjustment heuristic
Define a bias.
Explain the potential impact that a bias may have on decision making.
Identify factors that may impact biases, such as:
Religious and spiritual beliefs
Identify categories of biases, such as:
Belief perseverance biases
Information processing biases
Define types of belief perseverance biases that an individual may possess, such as:
Conservatism bias: the tendency to revise one’s belief insufficiently when presented with new evidence
Confirmation bias: the tendency to focus on and interpret information in a way that confirms one preconceptions
Cognitive dissonance: tendency to experience mental stress or discomfort when holding two or more contradictory ideas, beliefs or values at the same time, or when performing an action contradictory to one’s ideas, beliefs or values, or when confronted by new information that contradicts existing ideas, beliefs or values
Hindsight bias: the belief that past events were predictable at the time they occurred
Illusion of control: the overestimation of one’s control over external events
Representativeness bias: the tendency to classify things based on a few characteristics without accounting for the base rates of those characteristics
Define types of information processing biases that an individual may possess, such as:
Anchoring and adjustment: the tendency to rely heavily on one piece of information when making a decision
Availability / familiarity / frequency / saliency / recency bias: the tendency to overestimate the likelihood of events that are more easily recalled given the recency with which they occurred or the emotional charge they hold
Framing bias: the tendency to draw different conclusions from different presentations of the same information
Self-attribution bias: the tendency to claim more responsibility for successes than failures
Sunk-cost bias: the decision to invest or spend money, time, effort, etc. despite new evidence that shows that the expected cost of doing so exceeds the expected benefits
Outcome bias: the tendency to judge a decision by its eventual outcome instead of based on the quality of the decision at the time it was made
Define types of emotional biases that an individual may possess, such as:
Affinity bias: the tendency to be drawn to those people, things or decisions that one views as being similar to themselves
Disposition bias: the tendency to sell an asset that has accumulated in value and resist selling an asset that has declined in value
Endowment bias: the tendency to overvalue an object because they possess it
Loss aversion bias: the tendency to view losses as more painful than similar amounts of gains
Overconfidence bias: the tendency to be overly sure of oneself and their ideas
Regret aversion bias: the tendency to avoid making decisions for fear of experiencing regret
Self-control bias: the tendency to choose those actions that provide gratification in the short-term over the long-term
Status quo bias: the tendency to choose to maintain the current situation rather than
Define additional biases for which financial planners may be susceptible, such as:
Curse of knowledge
Illusion of transparency
Fundamental attribution error
Define mental accounting.
Explain the general types of mental accounts.
Current income account
Future income account
Explain the relative propensity to consume from each type of mental account.†
Explain how mental accounting may impact decision making.
Explain how decision making may be impacted based on variables such as:
Individual’s initial point of reference
Individual’s aversion to loss
Individual’s view of guaranteed gains (losses) in comparison to expected gains (losses)
Probability of events occurring
Absolute and relative sizes of gain / loss
Identify potential points of reference that may be used in the decision making process, such as:
Starting point (i.e. $0, no goal, no plan)
Initial point (i.e. amount invested)
Current point (i.e. fair market value of investment)
Peak or trough point (i.e. highest investment value)
Future point (i.e. expected outcome or achievement of goal)
Explain the impact of loss aversion on decision making.