The Psychology of Investing / Edition 1

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Overview

The first book of its kind to delve into the fascinating and important subject of the psychology affecting investment. No other book provides this information because traditional finance focuses on developing the tools in which investors use to optimize expected return and risk. The author believes that understanding the psychology of investing is just as important as knowing the traditional investment topics. Combines behavioral knowledge from psychology, management, marketing, economics, and finance. Uses investment as well as non investment examples. For financial planners, investment managers, individual investors, or to be used as a training manual or reference in financial companies.
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Product Details

  • ISBN-13: 9780130930248
  • Publisher: Pearson Education
  • Publication date: 11/28/2001
  • Edition description: Older Edition
  • Edition number: 1
  • Pages: 95
  • Product dimensions: 6.02 (w) x 8.88 (h) x 0.12 (d)

Table of Contents

Preface
Ch. 1 Psychology and Finance 1
A Simple Illustration 2
Prediction 3
Long Term Capital Management 5
Behavioral Finance 6
What to Expect 6
Ch. 2 Overconfidence 9
How Overconfidence Affects Investor Decisions 10
Overconfidence and Risk 14
Illusion of Knowledge 14
Illusion of Control 16
Online Trading 17
Online Trading and Performance 18
Ch. 3 Fear of Regret and Seeking Pride 21
Disposition Effect 21
Disposition Effect and Wealth 22
Tests of Avoiding Regret and Seeking Pride 23
The Market for Houses 25
Selling Winners Too Soon and Holding Losers Too Long 26
Disposition Effect and News 27
Reference Points 28
Ch. 4 Considering the Past 31
House Money Effect 31
Snake Bite (or Risk Aversion) 32
Trying to Break Even 32
Effect on Investors 33
Endowment (or Status Quo Bias) Effects 33
Endowment and Investors 34
Memory and Decision Making 35
Memory and Investment Decisions 36
Cognitive Dissonance 37
Cognitive Dissonance and Investing 38
Summary 39
Ch. 5 Mental Accounting 43
Mental Budgeting 44
Matching Costs to Benefits 44
Aversion to Debt 46
Sunk-Cost Effect 46
Economic Impact 47
Mental Accounting and Investing 48
Ch. 6 Forming Portfolios 51
Modern Portfolio Theory 51
Mental Accounting and Portfolios 51
Perceptions on Risk 53
Risk Perception in the Real World 56
Building Behavioral Portfolios 56
Naive Diversification 58
Retirement Plans 59
Ch. 7 Representativeness and Familiarity 61
Representativeness 61
Representativeness and Investing 62
Familiarity 64
Familiarity Breeds Investment 65
Familiarity Breeds Investment Problems 67
Ch. 8 Investor Socialization and Mania 71
Sharing Investment Knowledge 71
Herding 72
Speed is of the Essence (Not!) 72
Investment Clubs 73
Market Mania 76
A Rose.com by Any Other Name 77
The More Things Change ... 78
Ch. 9 Self-Control and Decision Making 81
Short-Term versus Long-Term Focus 82
Controlling Yourself 82
Saving and Self-Control 83
401(k) and IRA Plans 84
Self Control and Dividends 85
Beating the Biases 87
Additional Rules of Thumb 90
Index 93
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Preface

An old Wall Street adage states that two factors move the market: fear and greed. Although true, this characterization is far too simplistic. The human mind is very sophisticated, and human emotions are very complex. The emotions of fear and greed just don't adequately describe the psychology that affects people. This book is one of the first texts to delve into this fascinating and important subject.

Few other texts provide this information because traditional finance has focused on developing the tools that investors use to optimize expected return and risk. This endeavor has been fruitful, yielding tools such as asset pricing models, portfolio theories, and option pricing. Although investors should use these tools in their investment decision making, they typically do not. We tend not to use these tools because psychology affects our decisions more than financial theory does.

Unfortunately, your psychological biases inhibit your ability to make good investment decisions. By learning about your psychological biases, you can overcome them and increase your wealth. You will notice that most of the chapters are structured in a similar way. I first describe the psychological bias and illustrate it with everyday behavior (such as driving a car). The effect of the bias on investment decisions is then described. Lastly, I use academic studies to show that investors really do have the problem.

This material does not replace the investment texts of traditional finance. Understanding psychological biases complements the traditional finance tools. Indeed, after reading this book you should be convinced that traditional tools are valuable.

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Introduction

An old Wall Street adage states that two factors move the market: fear and greed. Although true, this characterization is far too simplistic. The human mind is very sophisticated, and human emotions are very complex. The emotions of fear and greed just don't adequately describe the psychology that affects people. This book is one of the first texts to delve into this fascinating and important subject.

Few other texts provide this information because traditional finance has focused on developing the tools that investors use to optimize expected return and risk. This endeavor has been fruitful, yielding tools such as asset pricing models, portfolio theories, and option pricing. Although investors should use these tools in their investment decision making, they typically do not. We tend not to use these tools because psychology affects our decisions more than financial theory does.

Unfortunately, your psychological biases inhibit your ability to make good investment decisions. By learning about your psychological biases, you can overcome them and increase your wealth. You will notice that most of the chapters are structured in a similar way. I first describe the psychological bias and illustrate it with everyday behavior (such as driving a car). The effect of the bias on investment decisions is then described. Lastly, I use academic studies to show that investors really do have the problem.

This material does not replace the investment texts of traditional finance. Understanding psychological biases complements the traditional finance tools. Indeed, after reading this book you should be convinced that traditional tools are valuable.

Read More Show Less

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