Become a more strategic and successful investor by identifying the biases impacting your decision making.
In Behavioral Finance and Your Portfolio, acclaimed investment advisor and author Michael M. Pompian delivers an insightful and thorough guide to countering the negative effect of cognitive and behavioral biases on your financial decisions. You’ll learn about the “Big Five” behavioral biases and how they’re reducing your returns and leading to unwanted and unnecessary costs in your portfolio.
Designed for investors who are serious about maximizing their gains, in this book you’ll discover how to:
● Take control of your decision-making - even when challenging markets push greed and fear to intolerable levels
● Reflect on how to make investment decisions using data-backed and substantiated information instead of emotion and bias
● Counter deep-seated biases like loss aversion, hindsight and overconfidence with self-awareness and hard facts
● Identify your personal investment psychology profile, which you can use to inform your future financial decision making
Behavioral Finance and Your Portfolio was created for individual investors, but will also earn a place in the libraries of financial advisors, planners and portfolio managers who are determined to counteract the less principled and data-driven aspects of their decision making.
Table of Contents
Preface xv
Acknowledgments xxi
About the Author xxiii
Part I Introduction To Behavioral Finance 1
Chapter 1: What is Behavioral Finance and Why Does It Matter? 3
Why Behavioral Finance Matters 5
Behavioral Finance: The Big Picture 6
Standard Finance versus Behavioral Finance 15
Chapter 2: Introduction to Behavioral Biases 23
Introduction 23
Behavioral Biases Defined 24
Why Understanding and Identifying Behavioral Biases is Crucial 25
Categorization of Behavioral Biases 27
Differences between Cognitive and Emotional Biases 27
Difference among Cognitive Biases 28
Emotional Biases 29
A Final Word on Biases 31
Part II Belief Perseverance Biases Defined and Illustrated 33
Chapter 3: Belief Perseverance Bias #1: Cognitive Dissonance Bias 35
Bias Description 35
Am I Subject to Cognitive Dissonance Bias? 38
Investment Advice 39
Chapter 4: Belief Perseverance Bias #2: Conservatism Bias 41
Bias Description 41
Am I Subject to Conservatism Bias? 44
Investment Advice 45
Chapter 5: Belief Perseverance Bias #3: Confirmation Bias 47
Bias Description 47
Am I Subject to Confirmation Bias? 51
Investment Advice 52
Chapter 6: Belief Perseverance Bias #4: Representativeness Bias 55
Bias Description 55
Examples of Representativeness Bias 56
Am I Subject to Representativeness Bias? 60
Investment Advice 62
Chapter 7: Belief Perseverance Bias #5: Illusion-of-Control Bias 65
Bias Description 65
Example of Illusion of Control Bias 66
Am I Subject to Illusion of Control Bias? 69
Investment Advice 70
Chapter 8: Belief Perseverance Bias #6: Hindsight Bias 73
Bias Description 73
Example of Hindsight Bias 74
Am I Subject to Hindsight Bias? 76
Investment Advice 77
Part III: Information Processing Biases Defined and Illustrated 79
Chapter 9: Information Processing Bias #1: Mental Accounting Bias 81
Bias Description 81
Practical Application 83
Am I Subject to Mental Accounting Bias? 85
Investment Advice 88
Chapter 10: Information Processing Bias #2: Anchoring Bias 91
Bias Description 91
Example of Anchoring and Bias 92
Am I Subject to Anchoring Bias? 94
Investment Advice 95
Bonus Discussion: Investment Strategies That Leverage Anchoring Bias 96
Chapter 11: Information Processing Bias #3: Framing Bias 99
Bias Description 99
Example of Framing Bias 101
Am I Subject to Framing Bias? 105
Investment Advice 107
Chapter 12: Information Processing Bias #4: Availability Bias 109
Bias Description 109
Example of Availability Bias 110
Am I Subject to Availability Bias? 113
Investment Advice 114
Chapter 13: Information Processing Bias #5: Self-Attribution Bias 117
Bias Description 117
Example of Self-Attribution Bias 118
Am I Subject to Self-Attribution Bias? 119
Investment Advice 121
Chapter 14: Information Processing Bias #6: Outcome Bias 123
Bias Description 123
Am I Subject to Recency Bias? 125
Chapter 15: Information Processing Bias #7: Recency Bias 129
Bias Description 129
Example of Recency Bias 130
Am I Subject to Recency Bias? 134
Investment Advice 135
Part IV: Emotional Biases Defined and Illustrated 137
Chapter 16: Emotional Bias #1: Loss Aversion Bias 139
Bias Description 139
Example of Loss Aversion Bias 140
Am I Subject to Loss Aversion Bias? 142
Investment Advice 144
Chapter 17: Emotional Bias #2: Overconfidence Bias 145
Bias Description 145
Examples of Overconfidence Bias 146
Am I Subject to Overconfidence Bias? 148
Investment Advice 151
A Final Word on Overconfidence 153
Chapter 18: Emotional Bias #3: Self-Control Bias 155
Bias Description 155
Example of Self-Control Bias 156
Am I Subject to Self-Control Bias? 159
Investment Advice 160
Chapter 19: Emotional Bias #4: Status Quo Bias 163
Bias Description 163
Example of Status Quo Bias 164
Am I Subject to Status Quo Bias? 165
Investment Advice 167
Chapter 20: Emotional Bias #5: Endowment Bias 169
Bias Description 169
Example of Endowment Bias 170
Am I Subject to Endowment Bias? 172
Investment Advice 173
Chapter 21: Emotional Bias #6: Regret Aversion Bias 175
Bias Description 175
Example of Regret Bias 176
Am I Subject to Regret Bias? 179
Advice 180
Chapter 22: Emotional Bias #7: Affinity Bias 183
Bias Description 183
Example of Affinity Bias 184
Am I Subject to Affinity Bias? 186
Investment Advice 188
Part V: Behavioral Investor Types 189
Chapter 23: Staying on Target to Reach Financial Goals is Hard 191
Non-Financial Examples of
Self-Defeating Behavior 192
Financial Examples of Self-Defeating Behavior 196
Chapter 24: Introduction to Behavioral Investor Types 201
Introduction 201
What is My Behavioral Investor Type? 204
Step 1: BIT Orientation Quiz 205
Step 2: Bias Identification Quiz 210
Step 3: Advice for Each BIT 216
Summary 216
Chapter 25: Preserver Behavioral Investor Type 217
Upside/Downside Analysis 219
Bias Analysis of Preservers 220
Advice for Preservers 224
Chapter 26: Follower Behavioral Investor Type 225
Upside/Downside Analysis 227
Bias Analysis of Followers 228
Other Important Follower Biases: Hindsight, Cognitive Dissonance and Regret 232
Advice for Followers 233
Chapter 27: Independent Behavioral Investor Type 235
Upside/Downside Analysis 237
Bias Analysis of Independents 238
Self-Attribution 240
Conservatism Bias 241
Representative Bias 242
Advice for Independents 242
Chapter 28: Accumulator Behavioral Investor Type 243
Upside/Downside Analysis 245
Accumulator Bias Analysis 246
Advice for Accumulators 251
Chapter 29: Asset Allocation Case Studies for Each Behavioral Investor Type 253
Part VI: Behavioral Aspects of Portfolio Implementation 271
Chapter 30: Behavioral Finance Aspects of the Active versus Passive Debate 273
The Logic of Passive Management 274
The Potential Benefits of Active Management 274
Advice: Use the Best Practical Allocation for Your Portfolio 277
Chapter 31: Behaviorally Aware Portfolio Construction 279
Introduction 279
Goals-based Investing 280
Consolidating Accounts into a Portfolio View 281
Portfolio Approach 282
Chapter 32: Behavioral Finance and Market Corrections 285
The Most Recent Panic 286
Index 291
