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Behavioral Finance and Investor Types


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Table of Contents

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

About the Author

MICHAEL M. POMPIAN, CFA, CAIA, CFP, is a partner at Mercer Investment Consulting (formerly Hammond Associates) serving institutional and private wealth clients. Prior to joining Mercer, he worked at Merrill Lynch and PNC Private Bank, as well as the investment staff of a family office. Pompian holds the Chartered Financial Analyst (CFA) designation, is a Chartered Alternative Investment Analyst (CAIA) and a Certified Financial Planner (CFP). He is also a member of the CFA Institute (formerly AIMR) and the New York Society of Security Analysts (NYSSA). He holds a BS in management from the University of New Hampshire and an MBA from Tulane University. He is a regular speaker on the subject of behavioral finance and has published numerous articles on the subject. He is married with three sons and can be reached at mpompian@hotmail.com.

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