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Wiley Question Of The Week: Behavioral Finance and Investment Processes (Sponsored)

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Question

George Seconda, CFA, makes the following statement about his investments: “I use my pension plan to give me broad market exposure across many different asset classes. Contributions to the plan fulfill my savings needs; hence, any other assets that I have left each month, I use to speculate in highly levered contracts for differences (CFDs) and spread bets. It is reassuring to know that even if I lose all my CFDs and spread-betting funds, I will still have enough savings to provide for my retirement.”

Seconda is most likely:

A. using mental accounting and is likely to have an inefficient portfolio.

B. acting rationally by making sure his retirement needs are met before speculating in high-risk products.

C. suffering from inertia linked to status quo bias.

Answer: A

In viewing his pension contribution as savings toward retirement and using surplus funds to speculate in risky investments, Seconda is viewing his portfolio in layers with different risk objectives. This is due to mental accounting bias and is likely to lead to an inefficient portfolio versus what he could achieve if he viewed his assets as a single portfolio. Choice B is incorrect since a rational investor would view the portfolio as a whole. Choice C is incorrect since inertia leads investors to stick to initial allocations over the life of a fund. There is no indication that this is an issue here.

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What exactly is a Contract for Differences (CFD)?