Michael M. Pompian - Behavioral Finance and Your Portfolio

1 Cover

2 Title Page BEHAVIORAL FINANCE AND YOUR PORTFOLIO A NAVIGATION GUIDE FOR BUILDING WEALTH MICHAEL M. POMPIAN

3 Copyright

4 Dedication

5 Preface A Challenging Environment Why This Book? Who Should Use This Book? When to Use This Book Plan of the Book

6 Acknowledgments

7 About the Author

8 PART I: INTRODUCTION TO BEHAVIORAL FINANCE 1 What Is Behavioral Finance and Why Does It Matter? Why Behavioral Finance Matters Behavioral Finance: The Big Picture Standard Finance versus Behavioral Finance Notes 2 Introduction to Behavioral Biases Introduction Behavioral Biases Defined Why Understanding and Identifying Behavioral Biases Is Crucial Categorization of Behavioral Biases Differences between Cognitive and Emotional Biases Difference among Cognitive Biases Emotional Biases A Final Word on Biases

9 PART II: BELIEF PERSEVERANCE BIASES DEFINED AND ILLUSTRATED 3 Belief Perseverance Bias #1: Cognitive Dissonance Bias Bias Description Am I Subject to Cognitive Dissonance Bias? Investment Advice Note 4 Belief Perseverance Bias #2: Conservatism Bias Bias Description Am I Subject to Conservatism Bias? Investment Advice Notes 5 Belief Perseverance Bias #3: Confirmation Bias Bias Description Am I Subject to Confirmation Bias? Investment Advice 6 Belief Perseverance Bias #4: Representativeness Bias Bias Description Examples of Representativeness Bias Am I Subject to Representativeness Bias? Investment Advice Note 7 Belief Perseverance Bias #5: Illusion-of-Control Bias Bias Description Example of Illusion of Control Bias Am I Subject to Illusion of Control Bias? Investment Advice Notes 8 Belief Perseverance Bias #6: Hindsight Bias Bias Description Example of Hindsight Bias Am I Subject to Hindsight Bias? Investment Advice

10 PART III: INFORMATION PROCESSING BIASES DEFINED AND ILLUSTRATED 9 Information Processing Bias #1: Mental Accounting Bias Bias Description Practical Application Am I Subject to Mental Accounting Bias? Investment Advice Notes 10 Information Processing Bias #2: Anchoring Bias Bias Description Example of Anchoring and Bias Am I Subject to Anchoring Bias? Investment Advice Bonus Discussion: Investment Strategies That Leverage Anchoring Bias 11 Information Processing Bias #3: Framing Bias Bias Description Example of Framing Bias Am I Subject to Framing Bias? Investment Advice 12 Information Processing Bias #4: Availability Bias Bias Description Example of Availability Bias Am I Subject to Availability Bias? Investment Advice Notes 13 Information Processing Bias #5: Self-Attribution Bias Bias Description Example of Self-Attribution Bias Am I Subject to Self-Attribution Bias? Investment Advice Note 14 Information Processing Bias #6: Outcome Bias Bias Description Am I Subject to Recency Bias? Note 15 Information Processing Bias #7: Recency Bias Bias Description Example of Recency Bias Am I Subject to Recency Bias? Investment Advice

11 PART IV: EMOTIONAL BIASES DEFINED AND ILLUSTRATED 16 Emotional Bias #1: Loss Aversion Bias Bias Description Example of Loss Aversion Bias Am I Subject to Loss Aversion Bias? Investment Advice Note 17 Emotional Bias #2: Overconfidence Bias Bias Description Examples of Overconfidence Bias Am I Subject to Overconfidence Bias? Investment Advice A Final Word on Overconfidence Notes 18 Emotional Bias #3: Self-Control Bias Bias Description Example of Self-Control Bias Am I Subject to Self-Control Bias? Investment Advice Note 19 Emotional Bias #4: Status Quo Bias Bias Description Example of Status Quo Bias Am I Subject to Status Quo Bias? Investment Advice Note 20 Emotional Bias #5: Endowment Bias Bias Description Example of Endowment Bias Am I Subject to Endowment Bias? Investment Advice Note 21 Emotional Bias #6: Regret Aversion Bias Bias Description Example of Regret Bias Am I Subject to Regret Bias? Advice 22 Emotional Bias #7: Affinity Bias Bias Description Example of Affinity Bias Am I Subject to Affinity Bias? Investment Advice Note

12 PART V: BEHAVIORAL INVESTOR TYPES 23 Staying on Target to Reach Financial Goals Is Hard Non-Financial Examples of Self-Defeating Behavior Financial Examples of Self-Defeating Behavior Notes 24 Introduction to Behavioral Investor Types Introduction What Is My Behavioral Investor Type? Step 1: BIT Orientation Quiz Step 2: Bias Identification Quiz Step 3: Advice for Each BIT Summary 25 Preserver Behavioral Investor Type Upside/Downside Analysis Bias Analysis of Preservers Advice for Preservers 26 Follower Behavioral Investor Type Upside/Downside Analysis Bias Analysis of Followers Other Important Follower Biases: Hindsight, Cognitive Dissonance, and Regret Advice for Followers 27 Independent Behavioral Investor Type Upside/Downside Analysis Bias Analysis of Independents Self-Attribution Conservatism Bias Representative Bias Advice for Independents 28 Accumulator Behavioral Investor Type Upside/Downside Analysis Accumulator Bias Analysis Advice for Accumulators 29 Asset Allocation Case Studies for Each Behavioral Investor Type

13 PART VI: BEHAVIORAL ASPECTS OF PORTFOLIO IMPLEMENTATION 30 Behavioral Finance Aspects of the Active versus Passive Debate The Logic of Passive Management The Potential Benefits of Active Management Advice: Use the Best Practical Allocation for Your Portfolio Notes 31 Behaviorally Aware Portfolio Construction Introduction Goals-Based Investing Consolidating Accounts into a Portfolio View Portfolio Approach 32 Behavioral Finance and Market Corrections The Most Recent Panic Note

14 Index

15 End User License Agreement

1 Chapter 11Table 11.1 Portfolio Selection: Which Portfolio Seems Best?

2 Chapter 15Table 15.1 Sample of a Periodic Table of Investment Returns

1 Chapter 1Figure 1.1 Investor Returns from the 2019 DALBAR ReportFigure 1.2 The Behavioral Finance GapFigure 1.3 Robert Shiller, Sterling Professor of Economics Yale University a...Figure 1.4 Richard Thaler, PhD, 2017 Recipient of the Nobel Memorial Prize i...Figure 1.5 Meir Statman, PhD, Glenn Klimek Professor of Finance at the Leave...Figure 1.6 Daniel Kahneman, 2002 Nobel Prize Winner in Economic SciencesFigure 1.7 Professor Dan Ariely, James B. Duke Professor of Marketing

2 Chapter 2 Figure 2.1 Most Significant Behavioral Biases Affecting Client Investment De...Figure 2.2 Categorization of Twenty Behavioral Biases

3 Chapter 4Figure 4.1 Montier Observes That Analysts Cling to Their Forecasts

4 Chapter 6Figure 6.1 Sample-Size Neglect Diagnostic: Which Sequence of Coin Toss Resul...

5 Chapter 7Figure 7.1 A Sample Distribution of the Descending Outcome Sequence in “The ...

6 Chapter 11Figure 11.1 Which Line Is Longer?Figure 11.2 Which Line Is Longer?

7 Chapter 16Figure 16.1 The Value Function—A Key Tenet of Prospect Theory

8 Chapter 23Figure 23.1 The Dieter-Exerciser versus the Yo-Yo DieterFigure 23.2 Saver-investor versus the Over-Confident TraderFigure 23.3 The Risk-Averse Investor

9 Chapter 24Figure 24.1 BIT Identification and Advice ProcessFigure 24.2 Biases Associated with Each Behavioral Investor Type

10 Chapter 25Figure 25.1 Preserver Investor Type Characteristics

11 Chapter 26Figure 26.1 Follower Investor Type CharacteristicsFigure 26.2 Sample of a Periodic Table of Investment Returns

12 Chapter 27Figure 27.1 Independent Investor Type Characteristics

13 Chapter 28Figure 28.1 Accumulator Investor Type Characteristics

14 Chapter 30Figure 30.1 Percentage of Domestic Equity Underperforming the S&P 1500...Figure 30.2 Outperformance of Active Funds vs. Interest Rates