Free CFP Exam Psychology of Financial Planning Practice Questions

Financial self-efficacy refers to an individual's confidence in their own ability to successfully manage their finances and achieve financial goals. It is rooted in Bandura's broader concept of self-efficacy and reflects perceived competence rather than actual knowledge or wealth. A person's net worth relative to peers (B) describes relative wealth, not self-belief. Willingness to take investment risk (C) relates to risk tolerance, which is a separate psychological construct. Knowledge of financial terminology (D) describes financial literacy, which is distinct from self-efficacy; a person can have high literacy but low confidence, or vice versa.

The sunk cost fallacy specifically involves allowing irrecoverable past costs (money, time, effort already spent) to influence current and future decisions. For example, continuing to hold a failing investment because of the money already lost, or continuing to pay for a business that is clearly failing because of prior capital invested. Loss aversion, by contrast, is the broader psychological tendency to weigh potential losses approximately twice as heavily as equivalent potential gains when evaluating prospects. While related, they are distinct: sunk cost is backward-looking (what was already spent), while loss aversion is forward-looking (what might be lost). The claim that sunk cost is emotional and loss aversion is cognitive (A) reverses the typical classification — sunk cost is generally categorized as a cognitive bias, while loss aversion has strong emotional components. The sunk cost fallacy applies to non-monetary decisions as well (C), such as staying in a career because of years of education. Neither bias is rational (B); both lead to suboptimal decision-making.

A terminal diagnosis creates urgency across multiple planning domains simultaneously. Reviewing beneficiary designations ensures assets pass as intended. Exploring accelerated death benefits (a feature in many life insurance policies) can provide needed funds for care or quality of life. Ensuring powers of attorney are current protects against future incapacity. Medicaid planning may be relevant for long-term care costs. Discussing legacy goals honors the client's values and provides a sense of purpose during a difficult time.
Choice A is incorrect because focusing exclusively on estate planning and life insurance is too narrow — it misses important areas like accelerated benefits, powers of attorney, and the client's personal wishes.
Choice B is incorrect because liquidating all investments is an emotionally driven suggestion that fails to consider the surviving family's financial needs or the possibility that the client may live longer than expected.
Choice D is incorrect because deferring all planning wastes precious time when capacity exists and may result in planning opportunities being lost if the client's condition deteriorates faster than expected.