Private Wealth Management (2) - Richard Morrison case study

Hill refers his friend, Richard Morrison, the former CEO of Masury Bridge and Iron (MBI), to Keller to discuss his wealth goals. Keller meets with Morrison and gathers the following information:

  • Richard Morrison is 50 years old and his spouse, Meredith, is 49 years old. Both are healthy and both expect to live at least an additional 40 years.
  • The Morrisons have a 20-year-old son and would like to transfer 5% of their wealth to him during their lifetime.
  • Richard Morrison retired two years ago and intends to spend his time serving on philanthropic boards; Meredith does not work.
  • The Morrisons own 2 million shares of MBI, currently valued at $50 million, representing approximately 90% of their wealth.
  • MBI is a large, publicly traded company, and the Morrisons’ position equals approximately 1% of the total market capitalization.
  • The Morrison family depends on dividends from MBI for their day-to-day living expenses.
  • The cost basis of their MBI shares is close to zero, and the capital gains tax rate is 15%.
  • Richard Morrison is loyal to MBI, follows the stock closely, believes he knows the company better than other investors, and expects the company to continue to be a good investment in the future just like it has been in the past.
  • The Morrisons’ key objective is to maintain their current standard of living during retirement.

Explain three emotional biases that may affect Richard Morrison’s decision making.

Answer:

A number of emotional biases can negatively affect the decision-making of holders of concentrated positions. Specifically, Richard Morrison’s decision to diversify may be negatively affected by loyalty effects, overconfidence/familiarity, and status quo/naïve extrapolation of past returns. The facts indicate that Mr. Morrison is extremely loyal to MBI (loyalty effect); he believes he knows the company better than other investors (overconfidence/familiarity); and he expects the company to continue to be a good investment as it has been in the past (status quo/naïve extrapolation of past returns).

How is the last part a display of status quo bias? This is more of an availability bias/representativeness bias (cognitive biases). Further, the answer said “naive extrapolation” - a result of a framing bias (another cognitive bias).

This is very confusing for me - can anybody shed light on the bolded portion of CFAI’s answer?

Many thanks in advance.

Greetings friend!

Basically the emotional and cognitive biases can seem a bit confusing sometimes based on how they are explained, because it’s easy to get wrapped up in specific language. But let’s step back up to the 20,000 foot level and consider it generally:

Status quo bias = past performance reflects “the way things are” that will continue into the future, or being more comfortable thinking about things based on “the way things have been” rather than opening one’s eyes to reassess the correct state of things in the current moment . This can relate to how a firm is classified in your mind (it’s a growth company because that’s how it’s always been, while if you looked at the actual data you would see it’s not a growth company anymore)… or it can relate to a company that traditionally has been a good investment being kept considered as a good investment despite the price trajectory, which could make it a good company but a bad investment due to being overvalued etc.

Don’t worry overly much about the author’s “naive extrapolation” wording here - the author likely just means “non-thinking projection” of the past into the present. You won’t need this wording on the exam, it even might be PhD-speak by an author who might have difficulty speaking in layman’s terms.

Availability bias typically refers to recent or traumatic/memorable information becoming top of mind and clouding your judgement. Such as memories of a financial crisis that cause an investor to be overly cautious and not taking on the appropriate amount of risk to meet their objectives, or some recent earnings under/overperformance affecting how people view a stock, etc. Status quo bias, on the other hand, simply refers to thinking the way things have been are going to be the way things will be. It doesn’t have to be rather new/recent or impactful information - status quo simply refers to the past generally. Availability means “easy to recall” in this context, so availability bias refers to situations where certain past information that’s top of mind affects your decision-making. Status quo simply means inability to consider/embrace change based on a longer-term accumulation of past information and beliefs.

Cheers - good luck - you got this :+1:

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Thanks a lot @Greybeard_The_Elder. That helped. Appreciate it.

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