Understanding for Incorporation, client bias diagnoses into the enhanced marketing and sales of investment products whilst, building mutual and beneficial long-term relationships.

1. Fortuna Favi et Fortus Ltd.
Fortuna Favi et Fortus Ltd.
- excellence through knowledge

2. Investor Behavior
- towards Understanding Clients

3. Customer Types & Characteristics

4. Know Your Client Rule
It is required that dealer members and their investment advisors:
• Learn the essential facts relative to every client and to every order or
account accepted – the know your client rule.
• Ensure that the acceptance of any order for any account is within the
bounds of good business practice.
• Ensure that recommendations made for any account are appropriate for the
client and in keeping with his or her investment objectives, personal
circumstances and tolerance to bearing risk – the suitability principle.

5. Know-Your-Client: Prudence and
legislation is required as the cardinal
rule in making investment
recommendations.
All relevant information about a
client must be known in order to
ensure that the registrant’s
recommendations are suitable.
Know Your Client Rule

6. Client/Investor Bias

7. Bias In Clients
A bias can be described as a preference or an inclination (especially
one that inhibits impartial judgment) or an unfair act or policy
stemming from prejudice.
Behavioral biases fall into two broad categories - Cognitive and
Emotional
• Cognitive bias can be technically defined as basic statistical,
information processing or memory errors that are common to all
human beings. They can be thought of also as “blind spots” or
distortions in the human mind.

8. • Emotional biases: opposite
side of the spectrum from
illogical or distorted reasoning.
Emotions are physical
expressions, often involuntary,
related to feelings, perceptions
or beliefs about elements,
objects or relations between
them, in reality or in the
imagination.
Bias in Clients
• Impulse
• Intuition
• Feeling

9. Identification of Bias In Clients
- types of Bias

10. Overconfidence - Bias:
Unwarranted faith in one’s intuitive reasoning, judgments, and cognitive
abilities – i.e. investors are overconfident in their investing abilities.
Specifically, the confidence intervals that investors assign to their investment
predictions are too narrow.
Leads to underestimation of downside risk, trading too frequently and/or
trading in pursuit of the next hot stock, and holding an under diversified
portfolio all pose serious hazards to your wealth

11. Representativeness Bias:
In order to derive meaning from life experiences, people have developed an
innate propensity for classifying objects and thoughts.
When clients are faced by a new phenomenon that is inconsistent with any of
their pre-constructed classifications, clients subject such ‘new phenomenon’ to
the same classifications anyway, relying on a rough best-fit approximation to
determine which category should house and, thereafter, form the basis for their
understanding of the new element e.g., Sample size neglect

12. Cognitive Dissonance Bias
Cognitions, in psychology, represent attitudes, emotions, beliefs, or values;
and cognitive dissonance is a state of imbalance that occurs when
contradictory cognitions intersect.
When newly acquired information conflicts with preexisting understandings,
people often experience mental discomfort - a psychological phenomenon
known as cognitive dissonance.
Thus, When people modify behaviors or cognitions to achieve cognitive
harmony, however, the modifications that they make are not always rationally
in their self-interest.
Advice: investors must address feelings of unease at their source and take an
appropriate rational action.

13. Availability Bias
This is a rule of thumb, or mental shortcut, that allows people to estimate the
probability of an outcome based on how prevalent or familiar that outcome
appears in their lives.
People exhibiting this bias perceive easily recalled possibilities as being more
likely than those prospects that are harder to imagine or difficult to
comprehend.
Investors ignore potentially beneficial investments because information on
those investments is not readily available, or they make investment decisions
based on readily available information, avoiding diligent research.

14. Availability Bias
Categories of Availability bias that apply to investors include:
(1) Retrievability,
(2) Categorization,
(3) Narrow range of experience
(4) Resonance
1, Retrievability - Ideas that are retrieved most easily also seem to be the
most credible, though this is not necessarily the case.

15. 2, Categorization - People attempt to categorize or summon information that
matches a certain reference.
Different tasks require different search sets, but; when it is difficult to put
together a framework for a search, people often mistakenly conclude that the
search simply references a more meager array of results.
E.g., if a French person simultaneously tries to come up with a list of quality
U.S. vineyards and a corresponding list of French vineyards, the list of U.S.
vineyards is likely to prove difficult to create.
The French person, as a result, might predict that high-quality U.S. vineyards
exist with a lower probability than famous French vineyards, even if this is not
necessarily the case.
Availability Bias

16. Availability Bias
3, Narrow range of experience - When a person possesses a too restrictive
frame of reference from which to formulate an objective estimate, then
narrow range of experience bias often results.
4, Resonance - The extent to which certain, given situations resonate vis-à-vis
the individuals’ own, personal situations can also influence judgment.
For example, fans of classical music might be likely to overestimate the
portion of the total population that also listens to classical music.

17. Anchoring and Adjustment Bias
When required to estimate a value with unknown magnitude, people generally
begin by envisioning some initial, default number—an anchor—which they
then adjust up or down to reflect subsequent information and analysis.
The anchor, once fine-tuned and reassessed, matures into a final estimate.
Investors exhibiting this bias are often influenced by purchase points—or
arbitrary price levels or price indexes—and tend to cling to these numbers
when facing questions such as:
Should I buy or sell this security?
Is the market overvalued or undervalued right now?

18. Self-Attribution Bias
Refers to that tendency of individuals to ascribe their successes to innate
aspects, such as talent or foresight, while blaming failures on outside
influences, such as bad luck.
E.g., athletes often reason that they have simply performed to reflect their own
superior athletic skills if they win a game, but they might allege unfair calls by
a referee when they lose a game. Can be of two types:
Self-enhancing bias represents people’s propensity to claim an irrational
degree of credit for their successes.
Self-protecting bias represents the corollary effect—the irrational denial of
responsibility for failure.

19. Self-Attribution Bias – Contd’
Implications for Investors: Irrationally attributing successes and failures can
impair investors by:
A, people who aren’t able to perceive mistakes they’ve made are,
consequently, unable to learn from those mistakes.
B, investors who disproportionately credit themselves when desirable
outcomes do arise can become detrimentally overconfident in their own
market savvy.

20. Illusion of Control Bias
The illusion of control bias describes the tendency of human beings to believe
that they can control or at least influence outcomes when, in fact, they cannot.
E.g., Casino patrons swear that they are able to impact random outcomes such
as the product of a pair of tossed dice.
Implications for Investors:
Investors might trade more than is prudent and maintain under-diversified
portfolios.
They use limit orders and other such techniques in order to experience a false
sense of control over their investments.
In general, it contributes to investor overconfidence.

21. Conservatism Bias
Conservatism bias is a mental process in which people cling to their prior
views or forecasts at the expense of acknowledging new information.
E.g, an investor receives some bad news regarding a company’s earnings and
that this news negatively contradicts another earnings estimate issued the
previous month. The investor might underreact to the new information,
maintaining impressions derived from the previous estimate rather than acting
on the updated information.
NB: Not to be confused with representativeness bias whereby people
overreact to new information.

22. Conservatism Bias contd’
Implications:
This bias might make investors cling to a view or forecast, behaving too
inflexibly despite being presented with new information.
It makes reactions to changes slow.
Might relate to an underlying difficulty in processing new information.

23. Ambiguity Aversion Bias
People do not like to gamble when probability distributions seem uncertain. In
general, people hesitate in situations of ambiguity- referred to as ambiguity
aversion.
Implications for Investors:
It may cause investors to demand higher compensation for the perceived risks
of investing in certain assets. Also, it may restrict investors to their own
national indexes (e.g., Standard & Poor’s 500) because these indexes are more
familiar than foreign ones.
Investors might believe their employers’ stocks are safer investments than
other companies’ stocks because investments in other companies are
ambiguous.

24. Endowment Bias
These clients value an asset more when they hold property rights to it than
when they don’t.
It is in line with standard economic theory, which asserts that a person’s
willingness to pay for a good or an object should always be equal to the
person’s willingness to accept dispossession of the good or the object, when
the dispossession is quantified in the form of compensation.
However it has been found that the minimum selling prices that people state
tend to exceed the maximum purchase prices that they are willing to pay for
the same good.
Effectively, then, ownership of an asset instantaneously endows the asset with
some added value.

25. Endowment Bias
Endowment bias can affect attitudes
toward items owned over long
periods of time or can crop up
immediately as the item is acquired.
Investors prove resistant to change
once they become endowed with
(take ownership of) securities.
Studies have shown that clients are
usually reluctant to sell inherited
securities.

26. Self-Control Bias
This bias is a human behavioral tendency that causes people to consume today
at the expense of saving for tomorrow.
E.g., Would you rather contribute N300 per month over the course of the next
12 months to some savings account earmarked for year-end tax payment?
Or
would you rather increase your federal income tax withholding by N300 each
month, sparing you the responsibility of writing out one large check at the end
of the year?
Rational economic thinking suggests that you should prefer the savings
account approach because your money would accrue interest and you would
actually net more than N3,600.

27. However, many taxpayers choose the withholding option because they realize
that the savings account plan would be complicated in practice by a lack of
self-control.
Self-control bias can also be described as a conflict between people’s
overarching desires and their inability, stemming from a lack of self-
discipline, to act concretely in pursuit of those desires.
This theory can be extended to the savings and consumption pattern in
individuals.
It is wise to espouse the pros & Cons of ‘saving today for the future’ both
verbally and with financial with models.
Self-Control Bias

28. Optimism Bias
Perception of the world through ‘rose tinted glasses’. Investors, too, tend to be
overly optimistic about the markets, the economy, and the potential for
positive performance of the investments they make.
Many overly optimistic investors believe that bad investments will not happen
to them—they will only afflict others.
Such oversight can damage portfolios because people fail to mindfully
acknowledge the potential for adverse consequences in the investment
decisions they make.
Instances of optimism bias include: overloading self with company stock, the
feeling of getting market-like returns etc.

29. Implications for Investors. Undue optimism can be financially harmful
because it creates, for investors, the illusion of some unique insight or
upper hand.
Financial advisors should understand investor optimism and respond by
counseling the pitfalls of overinvesting in company stock. Such advice
includes:
• Live below your means, and save regularly.
• Asset allocation is the key to a successful portfolio.
• Compounding contributes significantly to long-term financial success.
• Encourage the use of a financial advisor.
Optimism Bias

30. Mental Accounting Bias
This bias describes people’s tendency to code, categorize, and evaluate economic
outcomes by grouping their assets into any number of non-fungible (non-
interchangeable) mental accounts. According to Shefrin and Thaler : people
mentally allocate wealth over three classifications:
(1) current income, (2) current assets, (3) future income.
The propensity to consume is greatest from the current income account, while
sums designated as future income are treated more conservatively.
Thus people put money in separate “mental accounts” when presented with a
financial decisions. E.g., participants value cash more highly than credit card
remittances, though the source of both is identical

31. E.g., participants value cash more highly than credit card remittances, even
though both forms of payment draw, ultimately, from the participant’s own
money
Implications for Investors:
• Envisioning distinct accounts to correspond with financial goals, however,
can cause investors to neglect positions that offset or correlate across
accounts. This can lead to suboptimal aggregate portfolio performance.
• Investors to irrationally distinguish between returns derived from income
and those derived from capital appreciation.
Mental Accounting Bias

32. • Mental accounting bias can
cause investors to allocate
assets differently when
employer stock is involved.
• Mental accounting bias can
cause investors to hesitate to
sell investments that once
generated significant gains but,
over time, have fallen in price.
Mental Accounting Bias

33. Confirmation Bias
A type of selective perception that emphasizes ideas that confirm our beliefs,
while devaluing whatever contradicts our beliefs. i.e. it refers to our all-too-
natural ability to convince ourselves of whatever it is that we want to believe.
Thus, Investors often fail to acknowledge anything negative about investments
they’ve just made, even when substantial evidence begins to argue against
these investments.
E.g., Chat roomers who harass anyone that voiced a negative opinion of the
company they invested in. They seek confirmations of their beliefs rather than
try to glean insight into their company through other investors,

34. Hindsight Bias
“I knew it all along!” - Once an event has elapsed, people tend to perceive that
the event was predictable—even if it wasn’t.
This is because actual outcomes are more readily grasped by people’s minds
than the infinite array of outcomes that could have but didn’t materialize.
This is usually in an attempt to alleviate the embarrassment of being caught
off-guard under peculiar circumstances, blunting the ugliest of surprises and
populating our horizon
– i.e., it is the tendency of people, with the benefit of hindsight following an
event, to falsely believe that they predicted the outcome of that event in the
beginning.

35. Based on an assumption that the outcome observed is, in fact, the only
outcome that was ever possible.
There is an underestimation of the uncertainty preceding the event in question
and underrates the outcomes that could have materialized but did not.
Implications for Investors: It gives investors a false sense of security when
making investment decisions which, can manifest as excessive risk taking
behavior, and place people’s portfolios at risk.
Hindsight Bias

36. Loss Aversion Bias
According to D. Kahneman and A. Tversky, ..” people generally feel a
stronger impulse to avoid losses than to acquire gains.” Loss aversion can
prevent people from unloading unprofitable investments, even when they see
little to no prospect of a turnaround.
Implications for Investors.: Loss aversion is a bias that simply cannot be
tolerated in financial decision making. It instigates the exact opposite of what
investors want: increased risk, with lower returns. Manifestations include:
• Investors holding on to losing investments for too long.
• Investors to selling winners too early, in the fear that their profit will
evaporate unless they sell.

37. • Can also be the reason for
holding an unbalanced
portfolios.
E.g., if several investment
positions fall in value and
the investor is unwilling to
sell due to loss aversion, an
imbalance can occur.
Loss Aversion Bias

38. Recency Bias
Refers to a cognitive predisposition that causes people to more prominently
recall and emphasize recent events and observations than those that occurred
in the near or distant past.
Implications for Investors.
• Investors extrapolate patterns and make projections based on historical data
samples that are too small to ensure accuracy.
• Investors ignore fundamental value and focus only on recent upward price
performance.
• Investors ignore proper asset allocation and the need for portfolio re-
balancing.

39. Regret Aversion Bias
Displayed by clients that avoid taking decisive actions because of the hindsight
fear that, whatever course of action selected will prove to be less than optimal.
This bias seeks to prevent the pain of regret associated with poor decision
making.
Regret Aversion usually manifests as:
• Undue apprehension about breaking into financial markets that have
recently generated losses
• Causing clients to hold onto losing positions too long in order to avoid
admitting errors and realizing losses.
• Can cause “herding behavior” because, for some investors, buying into an
apparent mass consensus can limit the potential for future regret.

40. Framing Bias
A decision frame is the decision maker’s subjective conception of the acts,
outcomes, and contingencies associated with a particular choice.
The frame that a decision maker adopts is controlled partly by the formulation
of the problem and partly by the norms, habits, and personal characteristics of
the decision maker.
Implications for Investors:
An individual’s willingness to accept risk can be influenced by how
questions/scenarios are framed i.e. positively or negatively.
E.g., the subjective difference between the statement -“25 percent of patients
will be saved” and “75 percent of patients will die.”

41. Framing bias can cause communication
of responses to questions about risk
tolerance that are either unduly
conservative or unduly aggressive –
i.e. wording or the context in which
options are presented directly impact (or
frame) our selections.
*Bear in mind is that framing bias and
loss aversion bias can and do work
together.
Framing Bias

42. Status Quo Bias
This is a bias that prejudices clients facing an array of choice options to elect
whatever option ratifies or extends the existing condition (i.e., the “status
quo”) in lieu of alternative options that might bring about change. i.e.
preference for things to stay relatively the same.
Implications for Investors:
• By taking no action, clients could end up holding investments
inappropriate to their own risk/return profiles.
• Investors/clients might hold onto hold securities, either inherited or
purchased, because of an aversion to transaction costs associated with
selling.

43. Bias - Summary
Cognitive Biases: include Representativeness, Overconfidence, Anchoring and
Adjustment, Cognitive Dissonance, Availability, Self-Attribution, Illusion of
Control, Conservatism, Ambiguity Aversion, Mental Accounting, Confirmation,
Hindsight, Recency, Framing.
Emotional Biases: include Endowment, Self-Control, Optimism, Loss
Aversion, Regret Aversion, Status Quo

44. KNOW – YOUR – CLIENT!

45. Learning About Clients
Client Interviews:
Information gathering usually begins with a client interview during which the
investment advisor can learn about the client’s life and dreams and can
identify any issues or problems.
The initial interview is also a good opportunity for the advisor and client to
share their philosophies about investing to determine whether they will be able
to work together compatibly.
E.g., it ‘may not be’ appropriate for an aggressive investor to have an advisor
who is used to dealing with conservative investors.

46. Client Interviews (contd)
The investment advisor may find that some clients have difficulty expressing
certain concepts in words.
E.g., while many individual investors know where they want to be financially
in 10, 20, or 30 years, most have a hard time explaining how much risk they
are willing to accept to reach their goals.
To help obtain information that may not come out in an interview, most
investment advisors and firms use a standardized or customized client
questionnaire.
Learning About Clients

47. Interviewing Skills
• Guided Discussion: collect the required information e.g. checklist
• Probing:
Use both closed-ended and open-ended questions.
Do not fi re a barrage of questions at clients.
Remember that a question’s usefulness does not end when an answer has
been given.
When asking for personal information, use a lead-in to establish why they
need the information.
• Attending - respect for clients needs and express real interest in helping
achieve individual objectives.
Securing a comfortable and private area for conversation

48.  Routing incoming calls through voice mail or having an assistant take
them
 Facing the client squarely and openly and establishing direct eye
contact
 Focusing the conversation on the client’s needs and interests
• Active Listening: listen for the core meaning and relate it to other
information about the client before deciding on its significance and an
appropriate response.
• Empathy: be able to enter imaginatively into another’s world to understand
how the other person feels.
Interviewing Skills

49. Client Questionnaires:
Can be multiple choice (clients select from a pre-determined list of responses)
or open-ended (the client must write down the answer).
Some questionnaires focus on only one type of information needed to develop
a client’s investment policy, particularly the client’s attitudes toward risk,
while others gather a broader range of information.
Risk questionnaires are popular tools because of the difficulty clients have in
expressing their tolerance for risk.
A scoring system is normally utilized to evaluate client responses.
Learning About Clients

50. Questionnaires - Advantages
Questionnaires can be used to specify and prioritize generic financial and
lifestyle goals. - specifications about client goals and to express which goals
are more important than others.
Questionnaires can be used to pinpoint areas for client education. –
questionnaires can uncover inconsistencies in a client’s understanding
Family members can fill out additional questionnaires - separate questionnaires
can identify potential conflicts between two or more family members.

51. Questionnaires - Disadvantages
Clients may not understand some of the questions or may think
they understand them when they do not.
Do not automatically assume your client is as knowledgeable as
you are about investing.
Clients may think they can predict how they will react in certain
instances, but real life situations may produce entirely different
reactions. – when an actual market decline occurs, many investors
are not as bold as they formally thought.

52. Questionnaires - Disadvantages
Questionnaires are based on the assumption that clients take a holistic
approach to their assets. - Questionnaires, apply a single set of questions
to all client accounts as if each investor viewed all assets in the same
way.

53. What Advisors Need to Know
Information needed for the Investment policy statement IPS, is
divided into four categories:
• Personal situation
• Financial situation
• Personal and financial goals
• Attitudes toward risk

54. The Clients’ Personal Situation
• Age
• Marital status (single, married, divorced, separated)
• Number of dependents
• Employment details (type of work, job stability)
• Educational background (certification, post-graduate)
• Investing experience (number of years, types of securities)
• If married, all of the above information for the spouse
• If married, who makes the investment decisions

55. Client Financial Situation
• Amount of investable assets
• Annual income from all sources (other than investment income)
• Annual savings target (or a list of annual expenses)
• Type of investment accounts (cash accounts, margin accounts, registered
retirement plans)
• Other investments (company pension, employee stock options)
• Real estate (home, cottage)

56. Client Personal and Financial Goals
• Desired retirement age
• Desired retirement income
• Plans for major expenditures (vacation property, paying for a
child’s education, annual vacations)
• Gifting of assets (during lifetime or on death)

57. Attitudes Toward Risk
How do clients define risk –
(is it as income shortfall,
delayed retirement, less
wealth?)
• Client’s willingness to take
on risk
Attitude Behavior
(Its really
a two-
way
street)

58. Communication Skills For Advisors
• Speak clearly and slowly and be prepared to repeat what they say,
particularly if the client has any physical incapacity that limits their ability
to hear or understand.
• Avoid jargon and choose language appropriate to the client’s level of
understanding of investment-related matters.
• Be aware of cultural differences that may affect communications,
particularly non-verbal language that may be interpreted differently in
different cultures.
• Set aside any preconceptions when listening to clients, particularly about
appearance, ethnicity, social background, intellectual capacity, and age.

59. • Eliminate distractions from their environment as much as possible.
• Commit to getting to know the client from the client’s point of view.
• Monitor non-verbal communication for possible meanings.
• Separate the content from the emotion of messages and analyze each
one.
• Use empathy to make the relationship less distant.
Communication Skills For Advisors

60. Investor Behaviour
Standard finance theory assumes that investors are:
• Are risk-averse
• Have rational expectations
• Manage their portfolios as a whole
Behavioral finance theory, on the other hand, suggests that investors:
• Can be risk-averse or risk-seeking, depending on the situation
• Have biased expectations
• Practice mental portfolio accounting

61. Risk Aversion versus Risk Seeking
Standard Finance, investors are assumed to be risk-averse, that is, given
the choice between two investments with identical expected returns, they
will invest in the one with the least amount of risk, as measured by the
standard deviation of returns. But in reality, clients faced with the
possibility of a loss, are often risk seeking rather than risk averse.
In dealing with gains, people tend to be risk averse, but when dealing
with losses, they tend to be risk seeking.
This asymmetric attitude toward risk can help explain why some
investors are unwilling to sell securities that have gone down in value.

62. Rather than sell and realize the
losses, investors sometimes hold on
in the hope of a recovery, even if
there is a chance that the loss could
become even bigger.
• Standard deviation : is a
statistical measure of risk that
measures the extent to which
returns differ from the average or
expected level of return.
(*commit to memory)
Risk Aversion vs. Risk Seeking (1)

63. Biased Expectations
Standard finance assumes that investors have rational expectations, that
is, they all gather and act on information in an efficient and unbiased
way.
-i.e the “rational economic human being” is a model of human economic
behavior that hypothesizes that three principles rule economic decisions
made by individuals:
• Perfect rationality
• Perfect self-interest
• Perfect information

64. Behavioral finance commonly defined as the application of
psychology to understand human behavior in finance or investing. It
claims that most people vastly overstate their abilities.
E.g., in a magazine study a group of adult men were asked three
questions:
• How would you rate your ability to get along with others?
• How would you rate your ability as a leader?
• How would you rate your athletic ability?
Biased Expectations

65. In terms of their ability to interact with others, and no fewer than 25% said
they were in the top 1%.
A full 70% of the men placed themselves in the top quartile of leadership
ability, and 60% answered that they were in the top quartile as athletes.
Thus, people are can be a poor judge of their own abilities. Investment
advisors must keep this in mind when they assess client responses to questions
in interviews and on questionnaires.
Overconfidence may cause investors to believe they are more tolerant of risk
than they really are.
Biased Expectations

66. Mental Accounting
Standard finance assumes that investors consider their entire portfolio when
they make decisions.
Behavioral finance, suggests that people compartmentalize their portfolio
into different accounts.
Mental accounting refers to the phenomenon whereby people do not treat
their assets as a single portfolio, but keep track of them separately (Ref: earlier
referenced slides).
In practical terms, this means that an investor who made N6,000 investing in
one stock, but lost N5,000 investing in another, is likely to dwell on the
N5,000 loss, despite the fact that the investor’s overall wealth increased by
N1,000.

67. Investor Personality Types
Eight Investor Personality Types (IPTs) with three personality
dimensions:
• Idealism versus Pragmatism (I vs. P)
• Framing versus Integrating (F vs. N)
• Reflecting versus Realism (T vs. R)

68. Visual Depiction of Personality Dimensions
Idealism (I)
Framing (F)
Reflecting (T)
Pragmatism (P)
Realism (R)
Integrating (N)
Combinations of the three different personality dimensions results in
Eight Possible Investor Personality Types.
These are: IFT, IFR, INT, INR, PFT, PFR, PNT and PNR.

69. Idealism Versus Pragmatism (I vs. P)
Clients that 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.
E.g, many investors continued buying technology stocks even as they fell
during the meltdown in 2000, eternally optimistic that these stocks
would make a comeback - discerning patterns where none exist, and
believing their above-average market acumen gives them an exaggerated
degree of control over the outcomes of their investments.

70. Such clients are disinclined to thorough research and they can fall prey to
speculative market fads.
Idealists are susceptible to overconfidence, optimism, availability, self-
attribution, illusion of control, confirmation, recency and representativeness
biases.
On the other hand, Pragmatists, display a realistic grasp of their own skills and
limitations as investors - are not too overconfident about the capital markets and
demonstrate a healthy dose of skepticism regarding their investing abilities.
They understand that investing is an undertaking based on probabilities, and
research to confirm their beliefs.
Idealism Versus Pragmatism (I vs. P)

71. Framing Versus Integrating (F vs. N)
Framers: evaluate each of their investments individually and do not
consider how each investment fits into an overall portfolio plan. They are
rigid in their mental approach to analyzing problems.
Also they perceive their portfolio as composed of ‘unique’ money, rather
than a composite of well-managed investments.
E.g., these clients typically have different allocations for “retirement
money”, “vacation money” and “university savings”. This is not
necessarily a bad thing, but advisors need to watch for content overlap
amongst allocations to guard clients against over-concentrations in an asset
class.

72. Framers also subconsciously “anchor” their estimates of market or security
price levels, clinging to arbitrary purchase “points”, which leads to bias in
future calculations.
But Integrators, are characterized by an ability to contemplate broader
contexts and externalities. Correctly viewing 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, and are also flexible
in their approach to the market and security price levels.
Framing Versus Integrating (F vs. N)

73. Framers may be susceptible to
the following biases: anchoring,
conservatism, mental accounting,
framing and ambiguity aversion.
Integrators are investors who are
typically not susceptible to the
aforementioned biases.
Framing Versus Integrating (F vs. N)

74. Reflecting Versus Realism (T vs. R)
Reflectors have difficulty living with the consequences of their decisions and
have difficulty taking action to rectify their behaviors - justifying and
rationalizing incorrect actions and hesitating to own up to decisions that have not
worked out beneficially.
They are also prone to decision paralysis because they dread the sensation of
regret should they miscalculate.
E.g., holding inherited securities – out of a sense of loyalty to a deceased relative
– which may not be a good fit in a diversified portfolio in the current investment
environment.

75. Realists, on the other hand, have less trouble coming to terms with the
consequences of their choices. They don’t tend to scramble for excuses in
order to justify incorrect actions, and responsibility for their mistakes.
They don’t experience regret as acutely and, therefore, don’t dread it ahead
of time.
Reflectors may be susceptible to the following biases: cognitive
dissonance, loss aversion, endowment, self-control, regret aversion, status
quo and hindsight.
Realists are investors who are typically not susceptible to the
aforementioned biases.
Reflecting Versus Realism (T vs. R)

76. Application Of Bias In Asset Allocation
Low Level Of Wealth
(moderate)
High Level Of Wealth
(Adapt)
Emotional Bias
(Adapt)
Cognitive Bias
(Moderate)
Moderate & Adapt
Moderate & Adapt
Adapt
Moderate
Source: Pompian, M. and Longo, J. “Incorporating Behavioral Finance Into Your Practice.” Journal of Financial Planning, March 2005, 58–63.

77. Individual Clients may be better served by moving them up or down
the efficient frontier (a set of optimal portfolios), adjusting risk and
return levels depending upon the clients behavioral tendencies i.e.
client’s best practical allocation – Micheal Pompian
A best practical allocation may slightly underperform over the long
term and have lower risk, but is an allocation that the client can
comfortably adhere to over the long run.
Many clients, in response to a market downturn, want to sell in a
panic.
Incorporation of Bias In Asset Allocation

78. Incorporation of Bias In Asset Allocation
2 principles for constructing a best practical allocation, in light of client
behavioral biases:
• Moderate biases in less-wealthy clients; adapt to biases in wealthier ones -
client outliving his assets constitutes a far graver investment failure than his
inability to accumulate the greatest possible wealth.
• Moderate cognitive biases; adapt to emotional ones – emotional biases
originate from impulse or intuition rather than conscious calculation, they are
difficult to rectify. Whilst, cognitive biases stem from faulty reasoning, better
information and advice – they can be corrected.

79. Fortuna Favi et Fortus Ltd.,
:118 Old Ewu Road, Aviation Estate, Lagos,
:07032530965 | www.ffavifortus.com | info@ffavifortus.com