CFA Level II ExamPortfolio Management and Wealth PlanningMedium
A financial planner is advising a client who has expressed significant regret over past investment decisions, particularly selling winners too early and holding onto losers for too long. This client is exhibiting characteristics primarily associated with which behavioral bias?
- ASelf-Control Bias
- BEndowment Effect
- CRegret Aversion
- DMental Accounting
Show answer & explanationAnswer & explanation
Correct answer: C. Regret Aversion
Regret aversion is the tendency to avoid making decisions that could result in regretting a past decision. Selling winners too early might be an attempt to avoid the regret of watching gains disappear, while holding onto losers too long is often driven by the desire to avoid the regret of realizing a loss.
Why the other options are wrong
- A. Self-control bias involves failing to act in one's long-term best interest due to a lack of self-discipline.
- B. Endowment effect is the tendency to value something more once it is owned.
- D. Mental accounting involves treating money differently depending on its source or intended use.
Regret Aversion
Regret aversion is a cognitive bias where individuals make decisions to avoid the pain of regretting a past action or inaction.
- Can lead to holding onto losing investments too long (to avoid realizing the loss).
- Can lead to selling winning investments too early (to avoid regret of potential future loss).
- Often linked to the disposition effect.
Memory trick: Regret Aversion: Don't want to feel bad, so I'll just sit still, sad.