Investor BehaviorThe Psychology of Financial Planning and Investing
Wiley Finance 1. Aufl.
WINNER, Business: Personal Finance/Investing, 2015 USA Best Book AwardsFINALIST, Business: Reference, 2015 USA Best Book AwardsInvestor Behavior provides readers with a comprehensive understanding and the latest research in the area of behavioral finance and investor decision making. Blending contributions from noted academics and experienced practitioners, this 30-chapter book will provide investment professionals with insights on how to understand and manage client behavior; a framework for interpreting financial market activity; and an in-depth understanding of this important new field of investment research. The book should also be of interest to academics, investors, and students. The book will cover the major principles of investor psychology, including heuristics, bounded rationality, regret theory, mental accounting, framing, prospect theory, and loss aversion. Specific sections of the book will delve into the role of personality traits, financial therapy, retirement planning, financial coaching, and emotions in investment decisions. Other topics covered include risk perception and tolerance, asset allocation decisions under inertia and inattention bias; evidenced based financial planning, motivation and satisfaction, behavioral investment management, and neurofinance. Contributions will delve into the behavioral underpinnings of various trading and investment topics including trader psychology, stock momentum, earnings surprises, and anomalies. The final chapters of the book examine new research on socially responsible investing, mutual funds, and real estate investing from a behavioral perspective. Empirical evidence and current literature about each type of investment issue are featured. Cited research studies are presented in a straightforward manner focusing on the comprehension of study findings, rather than on the details of mathematical frameworks.
Acknowledgments xv Part One - Foundations of Investor Behavior Chapter 1 - Investor Behavior: An Overview 3 H. Kent Baker and Victor Ricciardi Introduction 3 Organization of the Book 11 Summary 20 References 21 About the Authors 23 Chapter 2 - Traditional and Behavioral Finance 25 Lucy F. Ackert Introduction 25 Traditional Finance 26 Behavioral Finance 31 Summary 39 Discussion Questions 39 References 39 About the Author 41 Chapter 3 - Behavioral Economics, Thinking Processes, Decision-Making, and Investment Behavior 43 Morris Altman Introduction 43 Behavioral Economics, Heuristics, and Decision-Making 44 Investment Heuristics and Investing in Financial Assets 45 The Trust Heuristic and Decision-Making 48 Other Critical Decision-Making Heuristics 49 Rational Investor Decision-Making in a World of Complex Information 56 Summary 58 Discussion Questions 59 References 59 About the Author 61 Part two - Personal Finance Issues Chapter 4 - Financial Literacy and Education 65 Michael S. Finke and Sandra J. Huston Introduction 65 Examples of Financial Literacy Measures 68 Financial Literacy and Behavior 71 Financial Literacy Education 75 Summary 77 Discussion Questions 78 References 78 About the Authors 81 Chapter 5 - Household Investment Decisions 83 Vicki L. Bogan Introduction 83 Financial Market Participation 83 Market Friction Effects on Household Investment Behavior 85 The Effects of Behavioral Biases on Household Investment Behavior 87 Summary 93 Discussion Questions 94 References 94 About the Author 98 Chapter 6 - Personality Traits 99 Lucia Fung and Robert B. Durand Introduction 99 A Structural Model of Personality 100 Risk-Taking Behavior 103 Overconfidence 104 Personality and Gender 105 Personality as a Guide for Investors 107 Summary 108 Discussion Questions 109 References 109 About the Authors 114 Chapter 7 - Demographic and Socioeconomic Factors of Investors 117 James Farrell Introduction 117 Literature Review 118 Case Study: The Florida Department of Education Employees 122 Summary 131 Discussion Questions 132 References 133 About the Author 134 Chapter 8 - The Effect of Religion on Financial and Investing Decisions 135 Walid Mansour and Mouna Jlassi Introduction 135 Religions and Economic Factors: Dependence or Bifurcation? 136 Religion and Individual Investing Behavior 138 Summary 147 Discussion Questions 147 References 147 About the Authors 151 Chapter 9 - Money and Happiness: Implications for Investor Behavior 153 Jing Jian Xiao Introduction 153 Can Money Buy Happiness? 154 Can Happiness Buy Money? 162 Implications for Investor Behavior 164 Summary 165 Discussion Questions 165 References 166 About the Author 169 Chapter 10 - Motivation and Satisfaction 171 Lewis J. Altfest Introduction 171 Classical Economic Motivation 171 Behavioral Economic Motivation 173 Maslow’s Hierarchy of Needs 175 Criticism of Maslow’s Hierarchy of Needs 177 Higher Level Motivation 179 Humanism 181 Maslow and Investment Management 182 Personal Finance Integration 183 Summary 185 Discussion Questions 186 References 187 About the Author 188 Part Three - Financial Planning Concepts Chapter 11 - Policy-Based Financial Planning: Decision Rules for a Changing World 191 Dave Yeske and Elissa Buie Introduction 191 Managing Behavioral Biases in the Financial Planning Engagement 194 A Process for Developing Financial Planning Policies 195 Applicability of Financial Planning Policies 199 Policy-Based Financial Planning: The Strategic Perspective 201 Example of Policies Derived through Stochastic Modeling 202 Sample Case Applications 203 Summary 205 Discussion Questions 206 References 206 About the Authors 207 Chapter 12 - Financial Counseling and Coaching 209 John E. Grable and Kristy L. Archuleta Introduction 209 Financial Counseling: A Historical Perspective 210 Theoretical Approaches: A Financial Counseling Perspective 215 Financial Counseling in the Twenty-First Century 221 Summary 223 Discussion Questions 224 References 225 About the Authors 226 Chapter 13 - Financial Therapy: De-Biasing and Client Behaviors 227 Joseph W. Goetz and Jerry E. Gale Introduction 227 What Is Financial Therapy? 229 Brief History of Financial Therapy 231 Theoretical Foundations for Financial Therapy 232 The Practice of Financial Therapy 237 Future Research and Practice 240 Summary 240 Discussion Questions 241 References 241 About the Authors 243 Chapter 14 - Transpersonal Economics 245 Renée M. Snow Introduction 245 Historical and Spiritual Overview of Money 248 The Western Eco/House 252 An Alternative Perspective 254 The Open Eco in Financial Planning 256 Summary 260 Discussion Questions 261 References 261 About the Author 264 Chapter 15 - Advising the Behavioral Investor: Lessons from the Real World 265 Gregg S. Fisher Introduction 265 Risk, Return, and the Investor: A Complex Relationship 266 Investments with People Problems 269 The Impact of Investor Behavior on Portfolios 272 How Advisors Can Help the Behavioral Investor 275 Turning Bias into Benefit: How to Profit from Investor Behavior 278 Summary 281 Discussion Questions 281 References 282 Disclosure 283 About the Author 283 Chapter 16 - Retirement Planning: Contributions from the Field of Behavioral Finance and Economics 285 James A. Howard and Rassoul Yazdipour Introduction 285 A Life Cycle Financial Planning and Wealth Management Model 286 Demographic and Macroeconomic Context 287 Biases, Heuristics, and Framing Effects on Retirement Planning 288 Hyperbolic Discounting 291 The Role of the Brain in Financial Decision-Making 293 Financial Decision-Making Quality and Age 295 The Role of Self-Awareness and Self-Control 296 Trust and Retirement Saving and Planning: The Basics 297 Trust and Retirement Saving and Planning: The Decision 298 Trust-Based Implications for Retirement Saving and Planning 299 Discussion Questions 302 References 303 About the Authors 305 Chapter 17 - Knowing Your Numbers: A Scorecard Approach to Improved Medical and Financial Outcomes 307 Talya Miron-Shatz and Stephanie Gati Introduction 307 The Need for Better Control of Chronic Diseases 309 The Scorecard Approach 310 Target Population and Advantages 311 Content of the Take Care Scorecard 311 Considerations for Health and Financial Literacy Scorecards 313 Limitations 318 Implications for Financial Literacy 318 Summary 319 Discussion Questions 320 References 320 About the Authors 324 Acknowledgment 324 Part Four - Investor Psychology Chapter 18 - Risk Perception and Risk Tolerance 327 Victor Ricciardi and Douglas Rice Introduction 327 Risk Perception 328 The Relationship between Risk Perception and Risk Tolerance 329 An Overview of Risk Tolerance 329 Measurement of Risk Tolerance 332 The Role of Emotion in Risk Perception and Risk Tolerance 334 Risk-Taking Behavior: The Influence of Market Moods, Business Cycles, and Economic Shocks 336 Unresolved Issues in the Risk Domain 340 Summary 341 Discussion Questions 342 References 342 About the Authors 345 Chapter 19 - Emotions in the Financial Markets 347 Richard Fairchild Introduction 347 Behavioral Finance and Prospect Theory 348 Emotions 350 Emotions in the Financial Markets 351 Emotional Finance and Unconscious Emotions 353 Emotional Corporate Finance—A Formal Model 356 Summary 360 Discussion Questions 361 References 361 About the Author 364 Chapter 20 - Human Psychology and Market Seasonality 365 Lisa A. Kramer Introduction 365 Moods, Emotions, and Sentiment 366 Weather, Mood, and Markets 366 Daylight, Mood, and Markets 367 Daylight Saving Time Changes, Mood, and Markets 373 Elation, Deflation, and Markets 374 Summary 376 Discussion Questions 377 References 377 About the Author 380 Chapter 21 - Neurofinance 381 Richard L. Peterson Introduction 381 Neuroscience Primer 382 Research Methods 385 The Neuroscience of Financial Decision-Making 387 The Implications of Neurofinance Research for Practitioners 395 Summary 397 Discussion Questions 398 References 398 About the Author 401 Chapter 22 - Diversification and Asset Allocation Puzzles 403 Dimitris Georgarakos Introduction 403 Household Stock Market Participation 404 Changes in Household Portfolios across Time 407 Differences in Household Portfolios across Countries 408 Portfolio Diversification 410 Household Stock Trading Behavior 412 Summary 415 Discussion Questions 416 References 416 About the Author 420 Chapter 23 - Behavioral Portfolio Theory and Investment Management 421 Erick W. Rengifo, Rossen Trendafilov, and Emanuela Trifan Introduction 421 Prospect Theory and Expected Utility Theory 421 Safety-First Portfolio Theory 426 SP/A Theory 427 Behavioral Portfolio Theory 430 Behavioral Asset Pricing Model 432 The BAPM, CAPM, and Three-Factor Model 432 Summary 435 Discussion Questions 435 References 435 About the Authors 438 Chapter 24 - Post-Crisis Investor Behavior: Experience Matters 439 Joseph V. Rizzi Introduction 439 Behavioral Finance Framework 440 History Dependent Risk Tolerance: The Collective Memory Hypothesis 446 Summary 452 Discussion Questions 453 References 453 About the Author 455 Part five - Trading and Investing Psychology and Strategies Chapter 25 - The Psychology of Trading and Investing 459 Julia Pitters and Thomas Oberlechner Introduction 459 Personality Variables 461 Affect and Cognition 463 News, Rumors, and Market Mood 470 Summary 471 Discussion Questions 471 References 472 About the Authors 476 Chapter 26 - The Surprising Real World of Traders’ Psychology 477 Denise K. Shull, Ken Celiano, and Andrew Menaker Introduction 477 What Science Reveals about How People Think 478 I Need to Be a Hero Again 485 The Heart of a Quant 487 Summary 489 Discussion Questions 490 References 490 About the Authors 493 Chapter 27 - Trading and Investment Strategies in Behavioral Finance 495 John M. Longo Introduction 495 Distinction between Trading and Investment Strategies 496 Active versus Passive Investment Strategies and Behavioral Finance 496 Average Investors Suffer from Behavioral Biases 498 Problems with Traditional Investment Strategies 499 Short-Term Behaviorally Based Trading Strategies 503 Long-Term Behaviorally Based Investment Strategies 508 Current and Future Trends in Behavioral Finance Strategies 509 Summary 510 Discussion Questions 511 References 511 About the Author 512 Part Six - Special Investment Topics Chapter 28 - Ethical and Socially Responsible Investing 515 Julia M. Puaschunder Introduction 515 Socially Responsible Investment 515 Historical Emergence 517 International Differences 520 Institutional Harmonization of FSR 523 SRI in the Post 2008?2009 World Financial Crisis Era of Globalization 524 Summary 525 Discussion Questions 527 References 527 About the Author 532 Chapter 29 - Mutual Funds and Individual Investors: Advertising and Behavioral Issues 533 John A. Haslem Introduction 533 Advertising and Performance 534 Advertising, Expenses, and Flows 535 Advertising, Emotions, and Choice 536 Behavioral Persuasion In Advertising and Choice 539 Education, Financial Knowledge, and Choice 540 Emotions, Behavior, and Choice 542 Emotions, Behavioral Finance, and Choice 543 Financial Literacy and Active Management 544 Price and Performance Sensitivity and Repricing 546 Sentiment Contrarian Behavior and Actual Performance 548 Summary 550 Discussion Questions 552 References 552 About the Author 553 Chapter 30 - Real Estate Investment Decision-Making in Behavioral Finance 555 Eli Beracha and Hilla Skiba Introduction 555 The Real Estate Market and the General Economy 556 Real Estate Market and Financial Market 556 Inefficiencies and the Real Estate Markets 557 Observed Inefficiencies in Real Estate Markets 563 Summary 569 Discussion Questions 569 References 570 About the Authors 572 Answers to the Discussion Questions 573 Index 615
“Baker and Ricciardi have done an excellent job of soliciting articles that blend academic research with real-world applications that can be used by financial planners. Investor Behavior is an excellent book for anyone who wishes to detour from the beaten path of behavioral finance and to implement what has been learned about investor psychology to better understand traders and assist clients.” — Financial Analysts Journal
H. KENT BAKER is University Professor of Finance at American University's Kogod School of Business in Washington, DC. As one of the most prolific finance academics, he has authored or edited 21 books and published more than 150 refereed articles. He has consulting and training experience with more than 100 organizations, serves on multiple editorial boards, and is the Past President of the Southern Finance Association. Professor Baker holds eight earned degrees including three doctorates as well as CFA and CMA designations. VICTOR RICCIARDI specializes in current trends in behavioral finance. As Assistant Professor of Financial Management at Goucher College in Baltimore, Maryland, he has made important contributions to understanding the psychology of investing. Professor Ricciardi also serves as Coordinator of Behavioral and Experimental Research for the Social Science Research Network (SSRN). He edits several SSRN eJournals related to behavioral finance, financial history, behavioral economics, risk-taking behavior, and behavioral accounting.
Why do investors behave as they do? Investor behavior often deviates from logic and reason. Emotional processes, mental mistakes, and individual personality traits complicate investment decisions and increase the difficulty of comprehending clients' judgments. Behavioral decision-making can also have a detrimental influence if investment professionals ignore or fail to grasp this aspect of decision-making. Investor Behavior: The Psychology of Financial Planning and Investing is a collection of must-read chapters by leading scholars and practitioners. This book edited by H. Kent Baker and Victor Ricciardi, two leading experts in the psychology of investing, is indispensable for anyone who works with individual clients and needs to manage those difficult-to-predict investment decisions. This comprehensive volume provides essential contributions to the field of behavioral finance and economics including mental mistakes (heuristics), emotional issues, bounded rationality, biases, and risk perception. Investor Behavior also goes beyond the basics, introducing new and cutting-edge research on individual behavior in areas including financial therapy, motivation and satisfaction, transpersonal economics, personality traits, financial coaching, money and happiness, retirement planning, neurofinance, and evidenced-based financial planning. The book concludes with an authoritative selection of developments in such behavioral topics as ethical and socially responsible investing, real estate investing, and mutual funds. Each chapter in Investor Behavior focuses on real-world examples that can be easily understood and applied. Readers learn how practitioners are converting new research on human psychology into measurable performance gains. Current best practices and concrete applications for understanding and managing client behavior are presented alongside clear, scholarly explanations of theoretical principles. Investor Behavior is more than just a collection of information about investing tendencies. Knowing what clients tend to do is important, but without an in-depth psychological perspective, financial planners and investment advisers cannot predict which strategies are in the client's best interests. Applying the behavioral principles—the why of financial decisions—gives investment professionals an edge when converting biases into performance. This book could revolutionize how to approach client management. For both professionals who are new to the psychology of investing and those who want to stay current on essential research findings, Investor Behavior is required reading. The book is also highly valuable for educational purposes and includes discussion questions and answers for each chapter. Investment professionals, investors, and others interested in investor behavior cannot afford to overlook this book.
PRAISE FOR INVESTOR BEHAVIOR As behavioral concepts pervade more and more areas of practical finance, it can be increasingly difficult to keep track of the explosion of new ideas and applications. Investor Behavior draws together a huge range of specialist thinkers and practitioners to help us navigate, and apply, this burgeoning field to improving real world financial decision making. —Greg B. Davies, Head of Behavioral Finance, Barclays Baker and Ricciardi have put together the first scholarly book that captures the psychology, cognitive errors, and behaviors that permeate the financial planning industry. Financial planning is not just about efficient portfolios. It is also about client motivation and happiness when they often don't really know what they want. This book reveals the emotions, beliefs, personality, and biology that impact their decisions. Planners can know themselves and their clients better. Each chapter is a must read for all financial planners, financial advisors, and wealth managers... or anyone wanting to enter the industry. —John Nofsinger, Seward Chair in Finance, College of Business and Public Policy, University of Alaska Anchorage Professors Baker and Ricciardi have provided an essential book on the emerging trends in investment behavior as it relates to the dynamic nature of the investment management industry. Readers of Investor Behavior: The Psychology of Financial Planning and Investing are treated to a deep treatment of empirical evidence and current literature on the subject of behavioral finance in an easy-to-read manner. The collection of academic and practitioner talent contributing to this book is to my knowledge unprecedented. I highly recommend the book to both investors and financial market participants. —Michael Pompian, Author of Behavioral Finance and Wealth Management Readers of this book should come away with an appreciation of the factors that make the tasks of financial planning and investing so very complicated. Baker and Ricciardi have assembled a volume that documents our existing knowledge about investing from so many different angles. Beyond broad disciplinary perspectives such as economics, psychology, sociology, and neurology, the book informs us about all kinds of phenomena impacting investment behavior, such as reliance on fast and frugal heuristics, biases stemming from reliance on heuristics, seasonal affective disorder, personality types, demographics, and religion. Of special interest are the chapters that discuss how this interdisciplinary perspective can translate into meaningful advice to help investors make sensible decisions in a complex world. —Hersh Shefrin, Mario L. Belotti Professor of Finance, Santa Clara University The past several decades have seen remarkable contributions to knowledge about investor psychology and behavior within the burgeoning field of behavioral finance. This comprehensive book gives readers a solid grounding in theoretical and practical insights from this research essential for wise investment decision making. —Paul Slovic, Professor of Psychology, University of Oregon Star Treks' Mister Spock was the rational, unemotional agent whom Captain Kirk of the Starship Enterprise depended on. Homer Simpson was the opposite, hardly the person to whom you would entrust your well-being. Spock would embrace this book. Homer, perhaps pried by a Duff Beer, would discover that relying on this book to improve his choices is his only choice for Marge and the kids. Baker and Ricciardi have done a masterful job of selecting learned authors, selecting the right material for comprehensive coverage. The backbone of sound financial planning and investing, namely to understand how and why mistakes are propelled by psychology, is revealed in the pages of this book. Teachers, students, planners, investors, no matter how educated, should benefit from this book. Practicing its lessons and wisdom will make you infinitely better off for it. —Arnold Wood, President and Chief Executive Officer, Martingale Asset Management
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