Investing For Retirement Reading Quiz

The human brain is not a rational economic player. When faced with uncertainty, even the all-time investing minds may throw good money after bad, sell at the first sign of problem or make all manner of muddled financial decisions.

These flaws in our everyday determination-making, first chronicled in the 1970s past Israeli psychologists Daniel Kahneman and Amos Tversky, gave rise to the field known as behavioral economic science, which aims to mitigate the effects of these embarrassing foibles by heightening our awareness of them.

Accept this 8-question quiz to find out how clearheaded yous are when information technology comes to financial decision-making. Then read on to check your answers and learn more about some of the most common—and costly—pitfalls.

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1. You buy stock in XYZ Corp. and, after several lackluster earnings reports, find it'southward down 25% from what you paid for information technology. Which is the all-time form of action?

A. Reassess the stock every bit though it were a prospective investment

B. Hold on to the stock until it gets dorsum to at least the cost yous paid

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ii. A twelvemonth after buying two particularly promising stocks, i has surged while the other has slumped. How do you rate your operation?

A. You congratulate yourself on your stock-picking apprehending

B. You acknowledge you're only 1 for two

iii. Your investment advisor suggests a number of new stocks to replace several long-held, albeit underperforming, investments. How should you lot react?

A. You hold on to the old stocks because they've long been a trusted role of your portfolio

B. You listen to your advisor's reasoning and consider the new stocks over the old

4. You lot inherit $100,000 in greenbacks. What's your side by side footstep?

A. You hold the inheritance in cash while you evaluate and reevaluate possible investments

B. You invest the money according to the asset allocation in your existing retirement plan

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5. After the recent stock market correction, you lot review your investment plan. Which is the all-time course of action?

A. Maintain your electric current allocation considering your long-term goals remain unchanged

B. Majorly reduce your exposure to equities in an effort to insulate your portfolio confronting future shocks

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6. Your portfolio gains 10% for ii consecutive years, before losing one-half of those profits in year three. How practise you react to the ups and downs?

A. You don't fret the loss and remind yourself that your portfolio is still upwardly overall

B. You're upset and put your money in greenbacks to help minimize time to come losses

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vii. Although U.S. technology stocks accept helped your portfolio achieve double-digit annual growth, your financial advisor now believes the sector to be overvalued. What do you practise?

A. You explore other industries with an center toward diversification

B. You lot downplay your advisor's concerns and redouble your research on engineering trends

eight. You see a Tv interviewer praising a CEO for several new products her company has developed. Should you buy the stock based on the segment?

A. Yes, because of potentially market-moving news from a trusted source

B. No, because multiple factors make up one's mind a stock's operation

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The answers—and why they matter

1. Reply: A | Reexamining the investment is the right move. However, many investors volition instead hold a stock until information technology reaches a value they have in their head (the price they paid for information technology, say, or a previous high)—a behavioral bias known equally anchoring. Getting midweek to a number can counterbalance down your judgment, even when the toll yous're anchored to is irrelevant to the decision at paw.

In one seminal study, Kahneman and Tversky spun a wheel containing the numbers 0 through 100 and and then asked their enquiry subjects what percentage of the United Nations is made upwardly of African countries. When the wheel landed on 10, the boilerplate approximate was 25%, whereas when the number landed on 65, the average gauge was 45%. The numbers on the wheel had admittedly nothing to practise with the question at hand, merely they influenced the research subjects' estimates yet.

2. Answer: B | An honest assessment reveals your rails tape to be a lackluster 50/50. However, many investors will instead recall how they knew the surging stock was going to be a winner all along, while conveniently forgetting they were every bit hopeful almost the second stock—a failure of logic known equally hindsight bias.

Indeed, people consistently misremember the odds they assigned to an outcome once that event is known. In 1 landmark study, researchers surveyed groups of university students prior to former President Richard Nixon's quantum trip to China in 1972 about the probability of certain events taking place, such as a face-to-confront meeting with Chairman Mao Zedong. Surveyed again afterward the trip, the students often misremembered their predictions in light of what actually transpired—invariably giving themselves higher marks than were warranted.

iii. Answer: B | In theory, every position must continually earn its place in your portfolio, but in practice, we oft overvalue things simply because we already ain them—a mental miscue chosen the endowment effect. One way to counter the endowment result is to ask yourself whether the reason you bought a particular investment is however valid. It's possible in that location'due south a more appropriate investment for you—provided you're willing to let go of what you lot already own.

four. Reply: B | Putting your $100,000 windfall to work in the market may exist the right choice, since cash tends to underperform the stock market place over the long booty, even when it's invested at the market's peak. However, many investors suffer from assay paralysis, or option overload, which tin can crusade them to sit on the sidelines rather than make it the game. Indeed, a 2000 study found shoppers were 1½ times more likely to visit a display showcasing a large number of jams—but ten times more likely to brand a buy from ane with a more-limited pick.

5. Answer: A | When information technology comes to fiscal decisions, long-term trends are historically more reliable than nearly-term events. After all, it took merely xix trading days after the events of September 11 for the market to return to pre-9/11 levels.

Be that every bit it may, investors oftentimes forget this fact because of recency bias, or our predisposition to give added weight to events that have occurred recently. If a marketplace's been going up, for example, we tend to assume continued gains are therefore more than likely, whereas a recent correction can lead us to believe some other is right behind it.

six. Answer: A | Yous should experience as much pain from a 10% loss equally you practise pleasure from a ten% gain, but researchers accept concluded the pain of loss is roughly twice as powerful, psychologically speaking, as the pleasure from an equivalent proceeds—a phenomenon known as loss aversion.

As with many behavioral biases, the roots of such thinking are oftentimes attributed to the early on days of human existence, when the loss of a day'due south worth of food could spell disaster, whereas an extra day's worth of food might add little to your odds of survival.

7. Answer: A | Our decision-making is subject to confirmation bias—the unconscious tendency to gravitate toward evidence that supports what we already believe. In other words, if you're already heavily invested in applied science stocks, it may be fourth dimension to challenge your predisposition, not confirm it. Confirmation bias is amidst the more than pernicious of our behavioral tics, evident in everything from political polarization to overconcentration in a particular asset class.

8. Answer: B | Company fundamentals are a more reliable barometer of a stock's potential performance than the 24/7 news cycle. Unfortunately, humans more oftentimes judge probabilities based on how easily corroborating data comes to mind—a tendency known as availability bias.

In this particular case, a compelling Idiot box advent by a CEO risks crowding out other information that perhaps has a greater bearing on the company's stock. In fact, availability bias is one reason people believe they're much more likely to win the lottery than they actually are, as those who hitting the jackpot are heavily promoted while the multitudes who come upwardly empty go unmentioned.

Blocking behavioral biases

Sensation is only half the boxing. To truly overcome these mental miscues, consider adopting a more than objective arroyo to your investments by:

Relying on fundamentals:Clients tin evaluate a prospective investment confronting other opportunities—and even current holdings—using Schwab's comparison tools.
Reviewing your performance: Keep records of your trades—including your rationale for purchasing each investment—and evaluate them from time to time. If an investment is underperforming its benchmark or is no longer appropriate to your strategy, it may exist fourth dimension to dump it—even if that means taking a loss.
Working with an counselor: Seek out a second opinion, especially when because large changes to your portfolio or strategy. Unbiased, professional insights can assistance you reexamine your assumptions and eschew emotional decision making.

Learn more about behavioral finance.