Certified Financial Management Specialist Practice Exam

What psychological bias is characterized by a preference for investments that are familiar?

1. Cognitive Dissonance

2. Familiarity Bias

3. Attribution Bias

4. Confirmation Bias

The correct answer is: Familiarity Bias

The preference for investments that are familiar is known as familiarity bias. This psychological phenomenon occurs when investors favor assets, companies, or financial instruments that they recognize or have prior experience with, often ignoring potentially superior options that may be more unfamiliar. This tendency can lead to a concentric investment portfolio where greater weight is given to well-known stocks or funds, decreasing diversification and potentially increasing risk. Investors influenced by familiarity bias might overlook better investment opportunities simply because they are not as well-known. This can restrict their overall performance and investment growth, as they may concentrate their resources in industries or companies that do not offer the best returns due to overconfidence in their existing knowledge. In contrast, cognitive dissonance refers to the mental discomfort experienced when holding two conflicting beliefs, attribution bias relates to the tendency to attribute successes to one's own actions while blaming failures on external factors, and confirmation bias involves favoring information that confirms existing beliefs while disregarding contradictory data. While these biases impact decision-making, they do not specifically pertain to the inclination towards familiar investments.