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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Basics of Behavioural Finance

Caselet: Mr. Iyer, 45, invested Rs 5 lakh in a small-cap fund after it returned 40% last year. He says, 'It will keep giving such returns, so I do not need to diversify.' His reliance on the latest year's performance to forecast the future is most closely a result of:

This is recency bias: the investor over-weights the most recent year's strong return and extrapolates it into the future, ignoring longer-term performance and the need for diversification.

  1. ARecency biasCorrect
  2. BMental accounting
  3. CStatus quo bias
  4. DRegret aversion

Explanation

Recency bias leads investors to give excessive weight to recent events or returns when forming expectations. Mr. Iyer extrapolates one year's return into the future. Mental accounting involves separating money into mental buckets, and status quo bias is a preference for leaving things unchanged.

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