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CFA Level I · CFA Level I Exam · The Behavioral Biases of Individuals

During a sharp market decline, a client who has an IPS with a long horizon asks to move everything to cash, citing fear of further losses. Which bias is most likely driving the request, and which response is most appropriate?

Loss aversion is most likely the driver, and the best response is to revisit the IPS horizon, risk capacity and rebalancing policy. Emotional biases are hard to correct, so the adviser adapts to them while reaffirming the agreed long-term plan rather than abandoning it in a panic.

  1. ALoss aversion; revisit the IPS horizon and risk capacity and follow its rebalancing policyCorrect
  2. BAnchoring; wait until prices return to the purchase level
  3. CMental accounting; split the portfolio into more separate accounts

Explanation

Fear of further losses is an emotional bias, loss aversion. Because it is emotional, it is best moderated by returning to the IPS, which reflects the client's actual horizon and capacity for risk. Waiting for the purchase price is anchoring, and more accounts would not address the fear.

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