Monty Frost’s tax-deferred retirement account is invested entirely in equity securities. Because the international portion of his portfolio has performed poorly in the past, he has reduced his international equity exposure to 2%. Frost’s investment adviser has recommended an increased international equity exposure. Frost responds with the following comments:
a. Based on past poor performance, I want to sell all my remaining international equity securities once their market prices rise to equal their original cost.
b. Most diversified international portfolios have had disappointing results over the past five years. During that time, however, the market in Country XYZ has outperformed all other markets, even our own. If I do increase my international equity exposure, I would prefer that the entire exposure consist of securities from Country XYZ.
c. International investments are inherently more risky. Therefore, I prefer to purchase any international equity securities in my “speculative” account, my best chance at becoming rich. I do not want them in my retirement account, which has to protect me from poverty in my old age.
Frost’s adviser is familiar with behavioral finance concepts but prefers a traditional or standard finance approach (modern portfolio theory) to investments.
Indicate the behavioral finance concept that Frost most directly exhibits in each of his three comments. Explain how each of Frost’s comments can be countered by using an argument from standard finance.
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