Reading 10: Portfolios, Pyramids, Emotions, and Biases －LO address, security, potential, structured

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Some proponents of behavioral finance believe that investors structure their portfolios as pyramids. Which of the following best represents the resulting structure of their portfolios?

A) The bottom layer of an investors pyramid will be invested in stock with higher layers invested in bonds and cash.

B) Several pyramids of different sizes will be formed, each representing a different asset.

C) Several pyramids of different sizes will be formed, each representing a different funding requirement.

D) The bottom layer of an investors pyramid will be invested in bonds and cash with higher layers invested in stock.

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Answer and Explanation

Investors will structure their portfolios as pyramids, with the bottom layer invested in less risky assets to fund necessities. Once necessities are funded, higher levels of the pyramid are dedicated towards riskier investments.

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 3: Behavioral Finance
Reading 10: Portfolios, Pyramids, Emotions, and Biases
LOS b: Explain how portfolios can be structured as layered pyramids and how such structures address needs associated with security, potential, and aspiration.

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Tommy Shaver is saving for his retirement. Shaver invests as behavioral finance would predict. According to behavioral finance, which of the following best represents how Shaver will fund this objective?

A) Shaver will use a pyramid approach and fund it with safe investments at the bottom of the pyramid.

B) Shaver will use a modern portfolio approach and diversify across global stocks, bonds, and alternative assets.

C) Shaver will use a pyramid approach and fund it with safe investments at the top of the pyramid.

D) Shaver will use a modern portfolio approach and diversify across stocks and bonds. He will avoid alternative assets however.

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Answer and Explanation

If Shaver invests as behavioral finance would predict, he will use a pyramid approach and fund it with safe investments at the bottom of the pyramid.

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