Republic of the Philippines

Region V – Bicol
Division of Camarines Norte
Mabini Colleges Inc.
Daet

MIDTERM

CASE ANALYSIS:

BEHAVIORAL FINANCE

KATHY MAE JALATA

BSBA- Financial Management
2nd year – D

CESAR P. ABASOLO
Instructor
TITLE OF THE CASE: LOLA FLORA: AFRAID TO LOSE

INTRODUCTION

Behavioral finance is the study of the influence of psychology on the behavior of

investors or financial analysts. It includes the subsequent effects on the markets. It
gives emphasis on the fact that investors are not always rational, have limits to their
self-control, and greatly influenced by their own biases.

Lola Flora is a single 70-year old woman who was generated income totaling of
one million pesos which was produced by her investment portfolio. Ms. Leticia referred
to the financial advisor to assist Lola Flora regarding the situation of her portfolio. Lola
Flora’s primary financial goal is to support herself sufficiently. She also a fearful investor
in the reason that she was afraid to lose money. It obviously can be noticed her attitude
and behavior against any recommendation of the investment portfolio by the financial
advisor.

PERSPECTIVE

The Financial Advisor is the one who has rightful authority to make decision
about this case analysis, who thinks that it is necessary that Lola Flora’s municipal and
government bonds are not sufficient to support her expenses concerning the inflation
that will affect the value of the assets. In addition, financial advisor considers that the
Lola Flora’s behavior, has a great impact in making decision about her portfolio.

CENTRAL ISSUE

Considering all factors and details discussed in the case, the main problem to be
addressed on is the behavior of Lola Flora that greatly affects her to make decision to
arrive at a better investment portfolio and to achieve her financial goal.

STATEMENT OF OBJECTIVES

 To determine the behavioral finance biases of Lola Flora.

 To determine the impacts of that biases in the allocation of asset.
  To help Lola Flora to create decision for the portfolio investment.
 To arrive at new mean-variance optimized portfolio recommendation for the
investment portfolio of the investor.

BEHAVIORAL FINANCE BIASES

Here are the behavioral finance biases that Lola Flora’s portrays as an investor:

1. Loss Aversion Bias

Is a type of cognitive bias and sometimes known as ‘the prospect theory’. It

tackles about the idea of its not as simple as looking at how people hate losing, instead,
it’s how people hate losing more than they like winning. In conclusion, it gives emphasis
on a behavior of an individual on how they hate losses more than equivalent gains.

In Lola Flora’s case, she showed this bias through her behavior that she doesn’t
want to lose money just like what happened in her relative in the crash in 2011.

2. Status-quo Bias

It describes the attitude of one people when they choose the things to stay the
same by doing nothing or extra effort to change those decisions made previously.

Here, Lola Flora’s never followed the recommendations of the financial advisor to
change her portfolio.

3. Cognitive Dissonance

A type of bias that happens when newly obtained information conflicts with pre-
existing understandings, causing discomfort to decide on or adapt.

As stated, financial advisor suspected Lola Flora was discomfort at the prospect
of re-allocating the assets of the portfolio.

4. Illusion of Control

It is a positive trait that accompanied by negative consequences. Refers to the

overstated belief of influencing an outcome that is outside their ability to control.
 It was proven that Lola Flora have this kind of bias because on her own, thinks
that her government and municipal bonds will sufficiently support her expenses in her
life.

5. Self-Attribution

One of the biases that describes about the established concept in psychology
research and refers to individuals’ propensity to attribute successes to personal skills
and failures to factors beyond their control.

6. Overconfidence

These bias has two components: self-confidence in the quality of the information,
and the ability to act on said information at the right time for maximum improvement.

Lola Flora portrays biases of illusion of control, self-attribution and

overconfidence in the reason that she never changed her portfolio and due to her
behavior of being stubborn and inflexible in thinking. Without considering the
recommendations of financial advisors about the investment portfolio, she strongly
believes that she can make it on her own.

7. Optimism

Lola Flora thinks positively that her owned government and municipal bonds
would be better than re-allocating her investment portfolio.

EFFECTS OF BIASES

These biases that Lola Flora portrays has effects on her decision making
regarding her investment portfolio:

1. Loss Aversion
 Lola Flora would be irrationally risk averse and very afraid to take risk and
face the challenges about the investment and would affect her decision in
investing more to other equities and securities for more additional return
which keeping in her mind the possibility of loss.
 2. Status-quo
 She would never try to be open or receptive for the recommendations that
the advisor might suggest.
3. Cognitive Dissonance, Illusion of Control, Overconfidence, Self-Attribution,
Optimism
 Lola Flora would be regretful when something bad happens.
 She will never admit the mistakes that she might done in the future.
 She will be refuse to reallocate her portfolio to a better investment.

CONCLUSION

The root of any behavioral finance is the emotion we feel in every situation.
Investors, even though they are professional one, have feelings and put emotions when
deciding on something, most of the time, emotions weigh over the rational thinking.

Lola Flora portrays the biases of Loss of Aversion, Status-quo, Cognitive

Dissonance, Illusion of Control, Overconfidence, Self-Attribution, and Optimism. Due to
these biases, financial advisor must have sufficient knowledge to understand her
portfolio in order to address these biases, and to be able to endorse strategy on how to
succeed in primary financial goal in her life.

RECOMMENDATIONS

Financial Advisor should have new mean-variance optimized portfolio that Lola
Flora must followed or applied in order to have better allocation of her asset. The
advisor should also assist her on how to invest more in other equities and securities to
get more and higher return of what she has invested, and to be ready to the inflation in
the market that might affect the investments. Lola Flora shall also need to accept the
idea that there’s always risks in investing, to face the challenges, and the most
important is to change her investment’s personality for the succession of her financial
goal.
 Mean-Variance Behaviorally Change Change in
Output Adjusted in Percent
Variances
Recommendation Allocation Percent (Weighted
s Recommendatio (Absolute Average)
n Value)
Equities 20 30 -10 50% 10%
Fixed 70 70 0 0% 0%
Incomes
Cash 10 0 10 100% 10%
TOTAL 100 100 Bias Adjustment 20%
Factor

It is a recommended new mean-variance optimized asset allocation which

commonly cited rule of thumb that has helped simplify asset allocation. It states that
individuals should hold a percentage of stocks equal to 100 minus their age. So, for a
70-year old, 30% of the portfolio should be equities. The remaining percentage would
comprise of high-grade bonds, government debt, and other relatively safe assets.

ACTION PLAN

Recommendations Actions/Activities Person(s) Responsible

Compute new mean- Generating better re- Financial Advisor

variance optimized allocation of the assets for
allocation of asset. the better investment
portfolio.
Invest more to other kinds of Finding and investing to a Financial Advisor and Lola
securities and equities. more kind of investment Flora -- investor
other than bonds to get a
higher return that will surely
be added to the asset that
 will sufficiently support the
daily life expenses. And
preparing for the possible
events that will happen if
inflation affects the
investment.
Be ready to accept the Practicing various way for Lola Flora -- investor
changes and face the risk. the investment portfolio to
accept the new asset
allocation of portfolio and
taking risk to face those
challenges that are
inevitable.
Change the investment’s Turns the biases into Lola Flora – investor
personality. rational way of thinking.

Consider other factors

before making actions.

TITLE CASE: MR. PRESIDENT’S CONFIDENCE

INTRODUCTION
 Behavioral finance holds that investors are considered normal, not rational; they
have limits to their self-control just like an ordinary people, and are influenced by their
own biases, and make cognitive errors that can lead to wrong decisions.

A pharmaceutical executive who earns millions of pesos every year is a 50-year

old single, named Mr. President. He already saved million pesos despite living
excessively and spends too much in every occasion. Mr. President has his medical
problem in his past but now have cleared his bill of health. At the target age of
retirement, he wants to donate three million pesos to his alma mater. The financial
advisor knows Mr. president that he listens intently and receptive to any
recommendations but still he has behaviors that probably causing distortion in his
portfolio.

PERSPECTIVE

The Financial advisor concerns about the simple downward fluctuation that may
possibly affect Mr. President’s living expenses. The advisor thinks that the changes to
be recommended will not be agreed by Mr. President due to the behavior of him
towards his investments. Moreover, the advisor believes that with a less aggressive
portfolio, Mr. President can still meet his primary financial objectives.

CENTRAL ISSUE

The predicted severe downward market fluctuation that may affect the daily life
and health expenses and the behavioral biases that can probably change his portfolio.

STATEMENT OF OBJECTIVES

 To identify the existed biases that Mr. President portrays.

 To convince and prove to the investor the new portfolio would be better than the
old one.
 To address the concerns about the portfolio and on investment’s market.
 To re-allocate the asset’s investment portfolio based on the behavioral finance
biases.

BEHAVIORAL FINANCE BIASES

 Here are the identified finance biases of Mr. President:

1. MENTAL ACCOUNTING

It refers to the practice that an individual allot different levels of utility to each
asset group, and this affects investor’s decisions and other behaviors. It explains why
many investors designate some of their funds as “safety” capital which they invest in
low-risk investments, while treating their “risk capital” quite differently.

Mr. President portrayed this through his action that he saved approximately
P10.5 million pesos that creates pools of assets in one classification.

2. CONSERVATISM

Describes the people are unwilling to change their opinions. The tendency of this
bias is that people pay attention to information that supports their opinions and to ignore
the contrary evidence.

Financial advisor concerned about the response of Mr. President in regard to the
recommended conservative allocation.

3. REGRET AVERSION

This bias strives for a way to avoid the emotional pain of regret related with poor
decision making. These make people be regret averse who try to avoid suffering arising
from errors of commission and errors of omission.

Regarding on Mr. President’s case, the advisor thinks that he might regret for the
change for not being more aggressive in investments.

4. OVERCONFIDENCE

Overconfident investors overestimate the correctness of the information they

have, or because they think they have above average investment skills, trade more than
rational investors.

As known as well-grounded person, and self-aware and thinking that he is a very

good investor, Mr. President wanted to have an aggressive investment to avoid regret in
her life.
EFFECTS OF BIASES

1. Mental Accounting
o Mr. President will just focus on one asset account rather than considering
other accounts.
o He will invest in some risky in risky assets for gain and will treat others
more conservatively.
2. Conservatism
o Mr. President will adhere to an initial decision despite the new
recommendation of the advisor.
o He may be slow to adjust their assessment of the investments predictions
even after the company’s profitability deteriorates.
3. Regret Aversion
o Mr. President is afraid to feel the pain of regret that comes whenever there
are deterioration of profit.
o He might lead to choose stocks or securities of subjectively designated in
good companies even when an alternative stock has an equal or a higher
expected return.
4. Overconfidence
o Mr. President may be overconfident in the sense that he will
underestimate the instability of financial assets.
o He might want to invest aggressively that might cause riskier investment.

CONCLUSION

These were the identified behavioral finance biases that affect the decision
making for his investment portfolio – the Mental Accounting, Conservatism,
Overconfidence and the Regret Aversion. These biases have greatly effect about the
market fluctuations or the ups and downs in the market, which doesn’t be seen as
desirable but surely inevitable.

In conclusion, the financial advisor is responsible to help Mr. President decides

on how to save or continuously financed his daily living expenses including the health
expenses. Financial advisor and Mr. President must come into agreement about the
aggressiveness of the investment portfolio.

RECOMMENDATIONS

Financial advisor must generate asset allocation for a better investment portfolio.
The investor must consider the consequences of being aggressive investor in the event
of the market fluctuations and must be more receptive to the recommendations that
attributes as a well-grounded person. He shall also risk taker for being a less aggressive
investor because based on his portfolio and risk tolerance, a more balanced portfolio
better suits for his investment.

Conferring to the biases, for a better rate of return from his investment, he must
accept and face challenges as well as risk. Furthermore, with the help and assistance of
the advisor, he must obtain adequate life insurance to cover the gift to cover his
donation in case of emergency. He, with the help of the advisor shall also invest his
earnings to various investment not only for the cash to get the higher return and more
safe keeping of his assets.

Mean-Variance Behaviorally Change Change in

Output Adjusted in Percent
Variances
Recommendation Allocation Percent (Weighted
s Recommendatio (Absolute Average)
n Value)
Equities 70 50 20 29% 20%

Fixed 25 50 -25 100% 25%

Incomes

Cash 5 0 5 100% 5%

TOTAL 100 100 Bias Adjustment 50%

Factor
 For this asset allocation method, the bias adjustment factor is 50% because of
the adjustment for the allocation of assets. For a 50-year old man, 50% of the portfolio
should be equities, that indicates he shall have a balanced portfolio for the risk
tolerance of his investment.

ACTION PLAN

Recommendations Actions/Activities Person(s) Responsible

Generate asset allocation For the tolerance of risk of Financial Advisor

for the investment portfolio. investment, generating
balanced allocation of asset
would be better.
Being more receptive to the The investor must be more Mr. President – investor
recommendations about the receptive about the
investment portfolio. recommendations or
suggestions for a better
investment portfolio to meet
his primary financial goal.
Considering the
consequences of the
unpredictable fluctuations in
the market.
Be ready to face challenges Facing the challenges and Mr. President – investor
and risks. risks investing in a market
economy where the market
fluctuations cannot be
avoided.
Acquire adequate life Acquiring reliable and safe Mr. President – investor and
insurance of the donation. insurance for one of his the Life Insurance Company
primary financial goals, the for covering and insuring the
donation of money to his donation.
alma mater, in case of
 emergency that beyond the
man’s control.

TITLE OF THE CASE: CONSERVATISM OF PAMILYA BANAL

INTRODUCTION

Bias is human tendency that affects our behavior and perspective, based on
predetermined mental notions and beliefs and can be conscious and unconscious
biases.
 The Pamilya Banal is a financially well-informed having two children. Having bad
suffering in the past, the couple requested for a more conservative position of the
portfolio as when the advisor recommends a new one. They saved money as for their
preparedness for the college expenses and retirement expenses in their work. Working
for five years as a financial advisor, working for updating the financial plan. They were
considered as trend followers and can predict idea about losing their assets.

PERSPECTIVE

As a financial advisor working for five years in the Pamilya Banal, thinks that the
family have various behavioral finance biases that can have emotional impact in regard
to the decision making of the couple. The advisor thinks that with their predictable idea
has also have effect that will bring them to a great risk and loss of their investment
portfolio.

CENTRAL ISSUE

The main issue that must be solved and give concern is the conservatism of the
family about their decision making in allocating their portfolio is and those behavioral
finance biases that attributes to the issue of this case.

STATEMENT OF OBJECTIVES

 To detect the different behavioral finance biases of Pamilya Banal.

 To determine whether to moderate or to adapt to Pamilya Banal’s irrational
preferences.
 To compute a new re-allocation and a better mean-variance optimized portfolio
investment recommendation.

BEHAVIORAL FINANCE BIASES

The detected behavioral finance biases of the family of Banal are:

1. CONSERVATISM
 Pamilya Banal showed conservatism bias due to their requested more
conservative position of the mean-variance optimized allocation. And this bias refers to
the tendency to revise one’s belief insufficiently when presented with new evidence.

2. COGNITIVE DISSONANCE

Investors will ignore newly obtained information because it conflicts with their
previous view or perspective when it comes to the investment portfolio. Pamilya Banal
are not receptive when the financial advisor gave an advice about their portfolio.

3. AVAILABILITY

Refers to a cognitive and information processing bias where investors use a

shortcut, based on how familiar the outcome appears in their life.

4. REPRESENTATIVE

A cognitive and belief-perseverance bias where people make classifications

based upon their relevant past experiences.

In a reason, that Pamilya Banal experienced suffering in their past investments,

they observe easily remembered possibilities as the best choices that showed in their
perspective idea.

5. MENTAL ACCOUNTING

In here, Pamilya Banal have managed to save P1,500,000 which they hope
might serve as financial support for the college and retirement funds. It identifies three
components – first, captures how outcomes are perceived and experienced, how
decisions are made and subsequently evaluated; second, involves the assignment of
activities to specific accounts; and third, concerns the frequency with which accounts
are evaluated.

6. RECENCY

Investors give emphasis to the more recent events than those in the near or
distant past which is a considered cognitive bias and information processing bias.

7. ILLUSION OF CONTROL
 Investor think that they control investment outcomes and circumstances even in
the reality they cannot.

They portray the biases of recency and illusion of control because obviously
stated that they are trend followers and vulnerable to short-lived market fads, and they
tend to move in and out of classes in an effort to control their financial destiny.

8. HINDSIGHT

This bias defined a cognitive and belief-perseverance bias where people

remember their own forecasts of the future more precisely than they actually were.

Pamilya Banal showed this through their predictable idea about the risk they
might experience because of the past experience during the tech meltdown in 2000.

EFFECTS OF BIASES

These are the possible effects of the identified behavioral finance biases:

1. Conservatism
o Pamilya Banal will just give emphasis only on the information that
supports their opinions and might ignore the information that the advisor
recommends.
2. Cognitive Dissonance
o Similar to the conservatism bias, the family of Banal will disregard the
advisor’s recommendation and refuse to adapt the endorsement to
change portfolio allocation.
3. Availability Bias and Representative Bias
o They might avoid and might not be interested to invest more to other
equity securities.
o Due to the history of bad sufferings, the classifications can often produce
incorrect understandings or interpretations.
4. Mental Accounting
o Pamilya Banal may give less attention to the relationship between the
investments held in the different mental accounts.
 o It builds mental buckets or pooling of accounts that focus on the individual
accounts or classifications of assets rather than thinking generally.
5. Recency
 Investor will focus on the asset class on what is in favor today and often
focus on the price and not on valuation and can misleadingly generalize
future events.
6. Illusion of Control
 Investor have great confidence on their acts that they can control but in
reality they really cannot control the portfolio.
7. Hindsight
 What’s dangerous is that in the reconstruction of the past is that investors
get a wrong sense of security due to the fact that they think they have
prophetic powers.

CONCLUSION

These were the behavioral finance biases that greatly affect the portfolio
allocation of asset and the decision making of the couple Conservatism; Cognitive
Dissonance; Availability; Representative; Mental Accounting; Recency; Illusion of
Control; and the Hindsight. Financial advisor must be addressed by the financial advisor
to help the better allocation of asset in the investment portfolio, and to be able to
address the concern of the Pamilya Banal when it comes to the short-term and on long-
term investment. Importantly, the Pamilya Banal and the financial advisor shall have
deep communication to arrive on an agreement that will help each other side.

RECOMMENDATIONS

Mean-Variance Behaviorally Change Change in

Output Adjusted in Percent
Variances
Recommendation Allocation Percent (Weighted
s Recommendatio (Absolute
 n Value) Average)
Equities 50 58 -8 16% 8%
Fixed 45 36 9 20% 9%
Incomes
Cash 5 6 -1 20% 1%
TOTAL 100 100 Bias Adjustment 18%
Factor

This asset allocation was based from the requested conservative position of
portfolio that the Pamilya Banal wanted to implement. the bias adjustment factor is 18%
because of the adjustment that Financial Advisor generated to a new mean-variance
optimized allocation. For a 36 year-old couples, 58% of the portfolio should be equities,
that indicates they shall have a balanced portfolio for the risk tolerance of his
investment.

What is more is that the identified behavioral finance biases must be lessen in
order to come up with the great decision for the portfolio. The investors must also invest
more in other equity securities other than cash in order to have a higher return for the
preparation of the future preferences. Pamilya Banal must be more receptive and open
for all recommendations and other new information from third parties specifically from
the financial advisor. They must also consider the past experiences for today’s
operation of investment in order to face the risks and apply strategies to avoid loss or
any difficulties that happened in the history about their portfolio investment.

ACTION PLAN

Recommendations Actions/Activities Person(s) Responsible

Arrive at a new mean- Adjusting and re-allocating Financial Advisor

variance optimized asset the percentages to
allocation. generate at new optimized
 asset allocation for the
portfolio investment based
from the behavioral
finance biases.
More approachable to the The investor must be more Pamilya Banal – investors
recommendations about receptive about the
the investment portfolio. recommendations or
suggestions for a better
investment portfolio to
meet their financial
foundation.
Invest more in other equity Investing to the other Pamilya Banal – investors
securities other than cash. equity securities in order to
and Financial Advisor
get higher return for future
expenses and fundings.
Consider the past Considering the past Pamilya Banal – investors
experiences for the experiences for today’s
present and future operation of investment is
preparation and success of a good help in order to
the financial goal. face the threats and apply
schemes to avoid loss or
any difficulties that
happened in the history
about their portfolio
investment.
References:

 Bryne Alistair. Behavioral Finance. 2013. Vanguard Asset Management

 Stupavsky, Michal., Behavioral Finance Foundations for Investors., Slovakia,
April 2018.

Webliography:

 www.investopedia.com
 www.dailyfinance.com
 www.bheaviouralfinance.net
 https://uxdesign.cc/cognitive-biases
 www.behavioraleconomics.com
 www.sciencedirect.com
 www.corporatefinanceinstute.com