B E H AV I O U R F I N A N C E

PSDA 2

Case F: Joe
Joe travels with his stockbroker friends daily on the way to his office. He takes a keen interest in their
conversation and gathers more knowledge about stock market. He also has invested in shares which
have given him good returns due to which he trades in great volumes. Joe is highly confident about his
financial knowledge and acknowledges his past success to his effective evaluation skills. He trades
frequently. However, by the end of the month he is surprised to find that his investment did not yield
the expected returns.

PRESENTED BY
PARAKH MALHOTRA (005)
AKHIL AGGARWAL (024)
DRISHTI AGGARWAL (011)
 1 . Identify the behavioral biases of the investors and how is it affecting their asset allocation?
EMOTIONAL BIASES
• CONSCIOUS BIASES – Greed
The stocks give him good returns due to which he trades in
great volumes. It shows greed behavior of Joe as he invest to
earn more and more return without properly analyzing the
fundamentals.
• UNCONSCIOUS BIASES – Pride
He has invested in shares which have given him good returns
and he continue investing. This shows that Joe shows so much
excitement and pride and continue investing in the same.
• OVER-CONFIDENCE
Joe is highly confident about his financial knowledge and
acknowledges his past success. This shows that Joe rely only on
his past performances and do not consider checking recent
fundamentals thinking he had good financial knowledge which
ultimately led to losses. This shows that Joe is overconfident.
Asset allocation is affecting the Joe’s portfolio as we can see that by
the end of the month, he is surprised to find that his investment did
not yield the expected returns. The biases had impacted him
negatively. If he would have done the fundamental analysis instead
of focusing more on preconceived, he would yield more returns.
COGNITIVE BIASES
• REPRESENTATIVENESS
He has invested in shares which have given him good
returns. This shows he depends on the past performance(event)
that exist in his mind that he earns good returns by ignoring the
present.
• HERDING BEHAVIOUR
Joe travels with his stockbroker friends daily on the way to
his office. He takes a keen interest in their conversation and
gathers more knowledge about stock market. This shows that
he daily listens to them and act accordingly what they are also
doing without considering his own judgement.
• OPTIMISM
Stocks have given Joe good returns due to which he trades in
great volumes. This shows that he overestimates the tendency
of gaining good gains and ignore the present fundamental
analysis.
• CONSERVATISM
Joe acknowledges his past success to his effective evaluation
skills. This shows that he believed on their preconceived notion
ignoring the present fundamental analysis.
 2. Should the advisor try to moderate the impact of these biases or adapt to them?

Given that Joe is risk loving (when he gets good returns due to which he trades in great volumes). As we can see, Mr.
Joe’s case yields a blended recommendation: advisor should advise to both moderate and adapt to his biases.
High Level of Wealth
(ADAPT)
Moderating and adapting means negotiating on
some middle ground.
Moderate
Emotional biases that Joe posses should be and Adapt
Adapt
adapted as they are harder to correct for because
they are based on feelings, which can be difficult Cognitive Biases Emotional Biases
(MODERATE) MR. JOE (ADAPT)
to change.
Also, Because they're happening in the Moderate Moderate
background of our minds, we are unaware of how and Adapt
we make decisions based on our bias.
Cognitive biases that Joe posses should be Low Level of Wealth
(MODERATE)
moderated as they stem from faulty reasoning
rather than an emotional predisposition. cognitive
errors typically result from faulty reasoning.
 3. What is the best practical allocation for each investor?

With the nature and wealth of the investors, it would be advised to decrease the risk taking investment as he is
investing 100% in stocks. The best practical allocation for Joe will be around 75% stocks, 15% fixed-income bonds
and 10% cash and cash-equivalents.

Investors like Joe would do better not only in investing, but also in all walks of life if they keep in mind the
behavioural biases that affect clarity in thinking. When Joe started making money he should reason his success by
appreciating an event which led him to make money out of it, weigh his strengths against his weaknesses rather than
blindly attributing all the success to himself and feel over-confident. If he will fail to yield expected return then the
result would not be favourable in the long run.