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Behavioral Finance and Investor Types: Managing Behavior to Make Better Investment Decisions

Behavioral Finance and Investor Types: Managing Behavior to Make Better Investment Decisions

Michael M. Pompian

ISBN: 978-1-118-01150-8

Aug 2012

256 pages

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Achieve investing success by understanding your behavior type

This groundbreaking book shows how to invest wisely by managing your behavior, and not just your money. Step by step, Michael Pompian (a leading authority in the practical application of Behavioral Finance concepts to wealth management) helps you plan a strategy targeted to your personality. The book includes a test for determining your investment type and offers strategies you can put into use when investing. It also includes a brief history of the stock market, and easy-to-comprehend information about stocks and investing to help you lay a solid foundation for your investment decisions.

Behavioral Finance and Investor Types is divided into two parts. Test Your Type, gives an overview of Behavioral Finance as well as the elements that come into play when figuring out BIT, like active or passive traits, risk tolerance, and biases. The book includes a quiz to help you discover what category you are in. Plan and Act, contains the traits common to your type; an analysis of the biases associated with your type; and strategies and solutions that compliment and capitalize on your BIT.

  • Offers a practical guide to an investing strategy that fits both your financial situation and your personality type
  • Includes a test for determining your tolerance for risk and other traits that will determine your investment type
  • Written by the Director of the Private Wealth Practice for Hammond Associates—an investment consulting firm serving institutional and private wealth clients

Behavioral Finance and Investor Types offers investors a better sense of what drives them and what puts on their breaks. By using the information found here, you'll quickly become savvy about the world of investing because you'll come to understand your place in it.

Foreword xi

Preface xiii

Acknowledgments xxi

PART ONE Introduction to Behavioral Finance 1

CHAPTER 1 Why Reaching Financial Goals Is Difficult 3

Nonfinancial Examples of Self-Defeating Behavior 4

Financial Examples of Self-Defeating Behavior 8

Summary 11

Notes 12

CHAPTER 2 Overview of Behavioral Finance 13

Behavioral Finance: Micro versus Macro 14

Standard Finance versus Behavioral Finance 15

The Role of Behavioral Finance with Private Clients 22

Practical Applications 22

Notes 24

CHAPTER 3 The Building Blocks: Behavioral Biases 25

Cognitive Biases 27

Emotional Biases 38

Summary 43

Notes 44

PART TWO Personality Theory 45

CHAPTER 4 Introduction to Personality Theory 47

History of Personality Theory 48

Four Main Personality Theories 50

Notes 65

CHAPTER 5 The History of Personality Testing 67

Types of Personality Tests 67

Summary 77

Notes 77

CHAPTER 6 The Behavioral Investor Type Framework 79

Reviewing the Original Process 81

The Behavioral Alpha Process: A Top-Down Approach 81

Updates to the Previous Model 85

Updated BIT Theory and Application 87

Summary 89

CHAPTER 7 Behavioral Investor Type Diagnostic Testing 91

Step 1: BIT Orientation Quiz 92

Step 2: Bias Identification Quiz 94

Summary 100

PART THREE Explanation of the Behavioral Investor Types 101

CHAPTER 8 The Preserver 103

Upside/Downside Analysis 104

Bias Analysis 105

Other Biases 107

Advice for Preservers 109

CHAPTER 9 The Follower 111

Upside/Downside Analysis 112

Bias Analysis 113

Other Biases 117

Advice for Followers 119

CHAPTER 10 The Independent 121

Upside/Downside Analysis 122

Bias Analysis 123

Advice for Independents 133

CHAPTER 11 The Accumulator 135

Upside/Downside Analysis 136

Bias Analysis 137

Other Biases 141

Advice for Accumulators 144

PART FOUR Plan and Act 147

CHAPTER 12 Capital Markets and Asset Classes 149

Overview of Asset Classes 150

Publicly Traded Equity Investments (Stocks) 154

Fixed Income Investments (Bonds) 163

Hedge Funds 172

Real Assets 176

Simple Portfolio Construction 180

Summary 182

Notes 182

CHAPTER 13 What Is Asset Allocation? 183

The Importance of Assumptions 185

The Importance of Strategic Asset Allocation 186

Considerations for Individual Investors 188

Why Asset Allocation Is So Important 197

Summary 200

Notes 200

CHAPTER 14 Financial Planning: A Crucial Step 201

What Is Financial Planning? 202

Working with a Financial Planner 203

What Is a Certified Financial Planner? 205

Who Can Provide Financial Planning Services? 209

Summary 212

Notes 213

CHAPTER 15 Investment Advice for Each Behavioral Investor Type 215

Foundations of Best Practical Allocation 216

Guidelines for Determining When to Moderate and When to Adapt 217

Best Practical Allocation for Preservers 219

Best Practical Allocation for Followers 222

Best Practical Allocation for Independents 224

Best Practical Allocation for Accumulators 227

Summary 229

Note 230

Index 231