Cognitive Bias

Topics: Cognitive bias, Daniel Kahneman, Investment Pages: 5 (1351 words) Published: March 19, 2013



Q1: How do the concepts of behavioural finance create opportunities for HelloWallet?
Private pensions are shifting more and more from defined benefit to defined contribution plans. This results in the shifting of responsibility for asset accumulation from the employers to the employees. As of 2008, the ratio of DC to DB pension plans is 3:1. Therefore, there will be more investors required to invest for retirement on their own. The company now has no long term pension liabilities to worry about.

Currently the model for HelloWallet does not incorporate behavioural finance into their analysis of an investor’s portfolio. The use of behavioural finance concepts will create the following opportunities for HelloWallet.

Availability Bias: People will be influenced more by what they can easily retrieve from memory. Availability bias is a human cognitive bias, which causes us to overestimate probabilities of events associated with memorable occurrences. A prime example of this would be plane crashes. Plane crashes are extremely rare; however, the vast majority of people widely overestimate their probability. This can be especially useful in media advertising to prospects that are experiencing “stress points”; being easily recalled from memory increases the likelihood that HelloWallet will be chosen.

Self-Control Bias: The software shows how the user is spending his money, and where they can save and where they can spend more while still investing towards their retirement. In this way, the software helps the user to balance the need for immediate satisfaction with long-term goals. It also shows when the investor gets off track of his financial goals. This can help to eliminate this bias. Keeping the client on track is the most important aspect of saving money. Regret Aversion: By showing the investor the potential savings loss from having not used HelloWallet in the past, and also by showing them the gain from currently using the software we can reduce the regret aversion of the investor. We must consider that the monthly cost of using HelloWallet should be low enough so that the investor does not see it as a huge cost of their portfolio over time. They can do this by showing the user how much they gain from using HelloWallet in comparison to using the more conventional methods of investing through banks, and investment houses. Since research showed that 27% of workers are not at all confident about retirement, the company can use this as part of its advertising to show that by using the service, clients will not regret having insufficient savings for retirement.

Mental Accounting bias: They can attract clients easily, if they can demonstrate achieving goals by placing assets in appropriate layers. In addition, educate them on the concept that separate income streams contribute to their total wealth and do not necessarily mean they need to be allocated to a specific goal. HelloWallet

should also take the opportunity to show them the risk reduction benefits from diversifying their portfolio, while taking into consideration the correlation between their assets.
Bounded rationality: Individuals exercise bounded rational behaviour, rather than take the time to analyze all available financial products, many individuals feel comforted by choosing products that are convenient for them. HelloWallet can expand the amount of information available to them since they provide access to information on 130,000 products available through 10,600 banks and financial institutions. In today’s day and age the internet plays a huge part of the average person’s development. The same rational goes for saving money. The more interactive and education the website is, the more knowledge clients will obtain. This in turn allows the user to make more informed decisions. In addition to this, the program is user friendly and shows all the potential...
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