Table of Contents
INTRODUCTION.
1. Your Behavior Matters!
Why haven't I Heard of This Before? A simple Illustration. Prediction. Behavioral Finance.
The Investment Environment. Endnotes.
I. NOT THINKING CLEARLY.
2. Overconfidence.
Becoming Overconfident. Illusion of knowledge. Illusion of Control. Recipe for Disaster?
Endnotes.
3. Overconfidence and
Investing.
Overconfidence: A Case Study I. Overconfidence and Trade Frequency. Gender Differences.
Trading Too Much. Overconfidence and Risk. Overconfidence and Experience. Mutual Funds.
Overconfidence and the Internet. Summing Up. Endnotes.
4. Status Quo - Or What I Own Is Better!
Endowment Effect. Endowment and Investing. Status Quo Bias. Attachment Bias. Overcoming
These Biases. Endnotes.
III. EMOTIONS RULE.
5. Seeking Pride and
Avoiding Regret.
Disposition Effect. Do We Really Sell Winners? Selling Winners Too Soon and Holding Losers
Too Long. The Disposition Effect and the Media. Avoiding the Avoiding of Regret. In
Summary. Endnotes.
6. Double or Nothing.
House Money Effect. Snake-Bit (Risk Aversion) Effect. Break-Even Effect. Would You Buy
This IPO? The Tech Bubble. Endnotes.
7. Social Aspects of Investing.
Sharing Investment Knowledge. Moving with the Hotel. Speed Is of the Essence (Not).
Investment Clubs. Beardstown Ladies. Investment Club Performance. Investment Club and
Social Dynamics. Summing Up. Endnotes.
III. FUNCTIONING OF THE
BRAIN.
8. Mental Accounting.
Mental Budgeting. Matching Costs to Benefits. Aversion to Debt. Sunk-Cost Effect. Economic
Impact. Mental Accounting and Investing. Endnotes.
9. Mental Accounting and
Diversification.
Mental Accounting and Portfolios. Risk Perceptions. Risk Perception in the Real World.
Building Behavioral Portfolios. Summing Up. Endnotes.
10. That's Not the Way I Remember It.
Memory and Investment Decisions. Cognitive Dissonance. Cognitive Dissonance and Investing.
Cognitive Dissonance and the Steadman Funds. Memory and Socialization. Reference Points.
Summing Up. Endnotes.
11. What I Know Is Better.
Representativeness. Representativeness and Investing. Familiarity. Familiarity Breeds
Investment. Familiarity Breeds Investment Problems. Endnotes.
IV. INVESTING AND THE
INTERNET.
12. The Internet (Psycho)
Investor.
The Rise of the Internet Investor. Amplifying Psychological Biases. Information and
Control. Online Trading and Overconfidence. Advertising - Increasing the Biases. Online
Trading and Performance. Day Traders - The Extreme Case. Summing Up. Endnotes.
13. Exuberance on (and
about) the Net.
A Rose.com by Any Other Name. A Bubble Burst. The More Things Change. The Boiler Room Goes
Online. Endnotes.
V. WHAT CAN I DO ABOUT IT?
14. Self-Control, or the Lack
of It!
Short-Term versus Long-Term Focus. Controlling Oursleves. Rules of Thumb. Environment
Control. Self-Control and Saving. IRA's. 401 (k) Plans. Self-Control and Investing.
Self-Control and Dividends. Summing Up. Endnotes.
15. Battling Your Biases.
Strategy 1: Understand Your Psychological Biases. Not Thinking Clearly. Letting Emotions
Rule. Functioning of the Brain. Strategy 2: Know Why You are Investing. Strategy 3: Have
Quantitative. Investment Criteria. Strategy 4: Diversify. Strategy 5: Control Your
Investing. Environment. Additional Rules of Thumb. In Conclusion.
Index.
Preface
Introduction
We are all prone to having
psychological preconceptions or biases that make us behave in certain ways. These biases
influence how we assimilate the information we come in contact with on a daily basis. They
also have an impact on how we utilize that information to make decisions.
Some of the decisions that
are influenced by our psychological biases can have a large impact on our personal wealth
- or the lack of it. I have written this book to try to show you how your own
psychological biases can creep into your investment decisions and sabotage your attempts
at building wealth.
WHAT TO EXPECT FROM THIS
BOOK
There are five parts in this
book. The first three parts illustrate different psychological biases that affect our
daily lives. The chapters in these parts are structured so they are similar to each other.
First, I identify the psychological trait and explain using common, daily activities. Then
I examine the degree to which investors are affected by the bias. Part 4 demonstrates how
the Internet exacerbates these psychological problems. Finally, the chapters in Part 5
describe what investors can do to help themselves.
The chapters in Part 1,
"Not Thinking Clearly," demonstrate how investment decision making is not always
rational. As you will see, people set their range of possible outcomes too narrowly. This
is part of a broader problem called overconfidence. Overconfident investors trade
too much, take too much risk, and earn lower returns. This topic is discussed in Chapter 2
and 3. If overconfidence causes investors to act too frequently, other biases described in
Chapter 4 causes investors to fail to act when they should.
Part 2, "Emotions
Rule," shows how the emotions associated with investing affect our decisions. Chapter
5 illustrates how an investor's view of himself causes him to avoid feelings of regret and
to seek pride. Consequently, investors sell winner stocks too soon and hold onto loser
stocks too long. Chapter 6 demonstrates that your past failures and successes have a
dramatic impact on your current decision making process. Lastly, our emotional state is
often affected by the social aspects of investing; we discuss this in Chapter 7.
The third part,
"Functioning of the Brain," shows how the human brain's processes for
interpreting and remembering information affect investors. For example, every day you are
bombarded by information. The brain uses a process called mental accounting to
store and keep track of important decisions and outcomes. Chapter 8 shows that as a
consequence of this process, people make poor financial decisions. Discussed in Chapter 9
is one particularly important implication of how investors view portfolio diversification.
The brain also uses shortcuts to quickly process information. This leads to impacts on
investor memory (Chapter 10) and the problem of representativeness and familiarity
(Chapter 11).
Part 4, "Investing and
the Internet," discusses the interaction among the Internet, psychology, and
investing. The Internet allows investors quick access to information, trading, and other
investors' opinions. However, these attributes actually magnify the psychological biases.
These issues are addressed in Chapters 12 and 13.
Finally, part 5, "What
Can I Do About It?" discusses what the investor can do to avoid these psychological
biases. The difficulty of maintaining self-control in the face of the psychological
biases is illustrated in Chapter 14. The last chapter shows that planning, incentives, and
rules of thumb are helpful in avoiding the common problems.
192 pages