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

Caselet: Mr. Rao, a 45-year-old executive, invested Rs 10 lakh in a thematic fund solely because it returned 40% last year, and says the fund 'will obviously keep doing well'. He also keeps 70% of his portfolio in shares of his own employer. Which bias best explains his reasoning about the thematic fund?

His reasoning reflects recency bias. He projects last year's 40% return forward as though it were a reliable trend, ignoring mean reversion and cyclicality of themes. The adviser should present long-term rolling returns and risk data rather than relying on the latest performance.

  1. ARecency bias, extrapolating recent returns into the futureCorrect
  2. BMental accounting
  3. CStatus quo bias
  4. DEndowment effect

Explanation

Assuming last year's high return will continue is extrapolation of recent performance, i.e. recency bias. Mental accounting is treating money differently by label. Status quo bias is preferring no change. Endowment effect is overvaluing what one already owns, which relates more to the employer shares.

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