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

Caselet: Ms. Rao, 40, invested heavily in a sectoral fund after it returned 45% last year and says it will keep doing so. Her goals are moderate and she has no emergency fund. Which bias is most evident in her expectation, and which adviser action is most suitable?

Ms. Rao shows recency bias, projecting last year's high return into the future. The adviser should explain that performance tends to revert, encourage diversification, set up an emergency fund, and align the allocation with her moderate goals and risk profile instead of chasing the sector.

  1. ARecency bias; explain mean reversion and align allocation to goals and risk profileCorrect
  2. BEndowment effect; advise her to hold the fund permanently
  3. CRegret aversion; advise switching funds every quarter
  4. DStatus quo bias; recommend no action

Explanation

Extrapolating last year's strong return into the future is recency bias. A suitable response is to educate on mean reversion and diversification, build an emergency fund, and match allocation to her goals and risk profile. The other options either mislabel the bias or advise action unsuited to her needs.

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