Investing Psychology E-Book

Tim Richards

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 469

Veröffentlichungsjahr: 2014

Beschreibung

Discover how to remove behavioral bias from your investment decisions For many financial professionals and individual investors, behavioral bias is the largest single factor behind poor investment decisions. The same instincts that our brains employ to keep us alive all too often work against us in the world of finance and investments. Investing Psychology + Website explores several different types of behavioral bias, which pulls back the curtain on any illusions you have about yourself and your investing abilities. This practical investment guide explains that conventional financial wisdom is often nothing more than myth, and provides a detailed roadmap for overcoming behavioral bias. * Offers an overview of how our brain perceives realities of the financial world at large and how human nature impacts even our most basic financial decisions * Explores several different types of behavioral bias, which pulls back the curtain on any illusions you have about yourself and your investing abilities * Provides real-world advice, including: Don't compete with institutions, always track your results, and don't trade when you're emotional, tired, or hungry Investing Psychology is a unique book that shows readers how to dig deeper and persistently question everything in the financial world around them, including the incorrect investment decisions that human nature all too often compels us to make.

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Investing Psychology

The Effects of Behavioral Finance on Investment Choice and Bias

TIM RICHARDS

Creator of the Psy-Fi Blog (www.psyfitec.com)

Cover image: ©iStochphoto.com/AmandaRuch ©iStochphoto.com/fatido Cover design: Wiley

Copyright © 2014 by Tim Richards. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Richards, Tim, 1961-     Investing psychology : the effects of behavioral finance on investment choice and bias / Tim Richards.        pages cm.—(Wiley finance series)     Includes bibliographical references and index.     ISBN 978-1-118-72219-0 (cloth)   1. Investments—Psychological aspects. 2. Finance—Psychological aspects. I. Title.     HG4515.15.R53 2014     332.601′9–dc23

2013050096

To Skyla, Alexa, and Hallie; for being there always, as I will always be here for you.

CONTENTS

Preface

CHAPTER 1 Sensory Finance

Beating the Bias Blind Spot

Illusory Pattern Recognition

Superstitious Pigeons—and Investors

The Super Bowl Effect: If It Looks Too Good to Be True, It Is

Your Financial Horoscope: Forecasting and the Barnum Effect

Uncertainty: The Unknown Unknowns

Illusion of Control

Stocks Aren't Snakes

Herding

Availability

Assuming the Serial Position

Hot Hands

Financial Memory Syndrome

Attention!

The Problem with Linda

Representation

The Seven Key Takeaways

Notes

CHAPTER 2 Self-Image and Self-Worth

The Introspection Illusion

Blind Spot Bias, Revisited

Rose-Colored Investing

Past and Present Failures

Depressed But Wealthy

Disposed to Lose Money

Loss Aversion

Anchored

Two Strangers

Hindsight's Not So Wonderful

Deferral to Authority

Emotion

Black Swans

Dirty Money, Mental Accounting

A Faint Whisper of Emotion

Psychologically Numbed

Martha Stewart's Biases

Retrospective

Annual Returns

Nudged

Mindfulness

The Seven Key Takeaways

Notes

CHAPTER 3 Situational Finance

Disposition vs. Situation

Beauty Is in the Eye of the Investor

Angels or Demons?

Merely Familiar

Lemming Time

Story Time

Wise Crowds?

Adaptive Markets

George Soros's Reflexivity

Grow Old Quickly

Speaking Ill

The Power of Persuasion

SAD Investors

Sell in May . . .

The Mystery of the Vanishing Anomalies

Tweet and Invest

Fire!

The Rise of the Machines

The Seven Key Takeaways

Notes

CHAPTER 4 Social Finance

Conform—or Die

Groupthink

Motivated Reasoning

Polarized

A Personal Mission Statement: Social Identity and Beyond

Gaming the System

You've Been Framed

Behavioral Portfolios

Dividend Dilemmas

The Language of Lucre

Embedded Investing

Financial Theory of Mind

Trust Me, Reciprocally . . .

Akerlof's Lemons

The Peacock's Tail

Facebooked

Be Kind to an Old Person

The Seven Key Takeaways

Notes

CHAPTER 5 Professional Bias

Mutual Fund Madness

Is Passive Persuasive?

Losing to the Dark Side

Forecasting—The Butterfly Effect

Forecaster Bias

Feminine Finance

Trading on a High

Marriage and Money

Muddled Modelers

CEO Pay—Because They're Worth It?

Corporate Madness

Buyback Brouhaha

Oh No, IPO

Your 6 Percent Self-Inflicted Trading Tax

Expert Opinion?

Avoid the Sharpshooters

The Seven Key Takeaways

Notes

CHAPTER 6 Debiasing

Numbers, Numbers, Numbers

Losing Momentum

Mean Reversion

Short Shift

Diworsification

Disconfirm, Disconfirm

Reverse Polarization

Expected Value

Investing in the Rearview Mirror

Living with Uncertainty

Sunk by the

Titanic

Effect

Changing your Mind

Love Your Kids, not Your Stocks

Cognitive Repairs

Satisficing

The Seven Key Takeaways

Notes

CHAPTER 7 Good Enough Investing

#1: The Rule of Seven

#2: Homo Sapiens, Tool Maker

#3: Meta-Methods

#4: Be Skeptical

#5: Don't Trust Yourself

#6: Self-Control Is Key

#7: Get Feedback

A Behavioral Investing Framework

Step #1: Making It Personal

Step #2: Build an Investing Checklist

Step #3: Write It Down

Step #4: Diarize Reviews

Step #5: Get Feedback

Step #6: Do Autopsies

Step #7: Update Adaptively

The Worst Offenders

Tools

The Mechanics of Investing

The Seven Key Takeaways

Notes

CHAPTER 8 A Few Myths More

Myth 1: Money Makes Us Happy

Myth 2: Everyone Can Be a Good Investor

Myth 3: Numbers Don't Matter

Myth 4: Financial Education Can Make You a Good Investor

Myth 5: I Won't Panic

Myth 6: Debt Doesn't Matter

Myth 7: I Can Get 7 Percent a Year from Markets

Myth 8: Inflation Doesn't Matter

Myth 9: Everyone Has Some Good Investing Ideas, Sometime

Myth 10: I Don't Need to Track My Results

The Seven Key Takeaways

Notes

CHAPTER 9 The Final Roundup

Notes

About the Companion Website

About the Author

Index

End User License Agreement

List of Illustrations

Chapter 1

FIGURE 1.1

The Müller-Lyer Illusion

FIGURE 1.2

The Müller-Lyer Illusion as a 3D Perception

FIGURE 1.3

+ Sign

Chapter 7

FIGURE 7.1

Seven Stages of Behavioral Investing Framework

Guide

Cover

Table of Contents

Preface

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Preface

As we move forward through the twenty-first century, it's more and more important for investors to understand the unconscious drivers that affect the way they make decisions about money because increasingly we're being left to fend for ourselves. It wasn't so long ago that retirees could look forward to a comfortable old age supported by employee sponsored, defined benefit pension plans and a generous social security system. Those days have gone, and more often than not we're being left to make our own investing decisions using 401(k) plans and other individually managed accounts.

At the same time, a vast expansion of the financial services industry has put us in charge of many more financial decisions—no longer are we limited in how much we can borrow by a wise old bank manager, but we are left to decide how much we can repay—and we must take the consequences when these decisions go wrong. This is especially so as a huge industry has grown up to exploit our biases, in order to part us from our money. The securities industry is a gigantic machine for extracting money from ordinary investors, and does so in a way that makes it all seem perfectly reasonable.

All this is happening as lifespans are lengthening due to improvements in medical care and a better understanding of healthy living. So the decisions we make about our money will determine whether our lengthening old ages are played out in comfort or misery. Learning how, and why, we make these decisions, and how we can improve them, should be a priority for all of us.

Although we've been given greater freedom of choice than ever before, we've not been granted any greater wisdom, or given any training about how to proceed. That's what this book is about, how to use the opportunity we've been given, how to avoid the traps set by our own minds and by those people who want to exploit them. It's a fascinating journey and one, I believe, that will leave you with a permanent advantage over those who don't choose to join us.

Although this is a book with a serious purpose, and is full of carefully chosen academic research to illustrate the points that I want to make, it is not, I hope, a seriously difficult read. Writing an important book that no one reads because it's too difficult and clever would be missing the point: unless this material is accessible to investors and their advisers, it can't help them. Equally, though, I'd urge you not to be fooled by the often light-hearted tone—this is a book with a very serious purpose—to help us figure out how to overcome the enemy within, our own brains. Because if we can't, then we will end up being seriously impoverished.

The book is divided into nine chapters, the first four of which deal with particular aspects of the behavioral flaws that drive us to throw our money at people who are already rich. This is a whistle-stop tour of dozens of different types of behavioral biases, which intends to kick away any illusions you have about yourself and your investing abilities and trample them into the dust.

We start by looking at how our senses often fool us into thinking that there are things going on out there, when they're actually only going on in our heads. Our brains are attuned to the world around us, and they function in a way that gives us the best chance of survival; but these behaviors are often not appropriate when we're investing. Believing that we can influence or even predict markets in a desperate attempt to keep our brains happy is a one-way ticket to penury.

The second chapter looks at how our feelings of self-image and self-worth impact our investing behavior. Far from being careful, emotionless analyzers of financial data, most of us are as concerned about whether it looks like we're good investors as whether we actually are. Above all, we're horribly overoptimistic about our investing talents, and we go to great care to avoid proving that we're wrong: none of which is designed to improve our finances.

We then move onto the tricky subject of situation—the nasty fact that how we invest depends not on rock-solid objective facts but is dependent on the situation we find ourselves in. Sometimes this situation is environmental, sometimes it's other people, but if we're not on our guard it will always influence our investing approach, and usually not in a good way.

The fourth chapter delves into the complex area of social interaction, and the ways that different forms of group behavior can change our investing decisions. It's possible to get people to change their minds simply by modifying the way we ask a question, and this is exploited by a wide range of different influencers, from politicians to corporate managements. We're social animals, and we're very susceptible to social pressures, even though we don't always realize it.

You might think that the various professionals in the securities industry would be better able to resist these different types of behavioral pressure but, as Chapter 5 discusses, the truth is somewhat different. Although many professionals are more capable of managing their biases than private investors, they're exposed to a range of different incentives—and incentives can change behavior, often in ways that aren't in our interests. By all means use a professional money manager, but make sure you know how to manage them.

Although the study of behavioral finance is over 40 years old, in many ways it's still in its infancy and, although increasingly we know what to look for, the techniques for dealing with the problems are lagging behind. In the next chapter we look at some investing methods and how they relate to behavioral bias and discuss some techniques that can be used to help debias our investing decision making. Perhaps the biggest takeaway is that bias will always be with us—it's when we think we've got it cracked that we're most at risk.

In Chapter 7 we develop these ideas around investing methods and debiasing techniques into a method, or rather a methodology, to affect cognitive repairs—in essence, to shore up our dodgy defenses with a method that forces us step-by-step to consider the main issues. Above all, though, this approach is one that emphasizes change rather than stasis—what works today may not work tomorrow and learning to deal with that is a major component in dealing with behavioral issues.

Many of our biases are actually justified by what I describe as myths—ideas that have taken hold of our minds and have become accepted truths. In Chapter 8 I identify a bunch of these and show why we need to question everything. All too often what we believe to be true is not, and refusing to accept any idea unquestioningly is a habit we need to get into if we're going to improve our investing decision making.

Finally, in the last chapter, I round all of this up into seven key takeaways—but I'd urge you not to jump to the end. In this case the journey is every bit as important as the destination, because if you don't know why you need to behave in a certain way you'll never understand what you need to do when the situation you're in changes. And, in investing, the situation changes all the time.

So, let's get started. Let's go meet the enemy: our own brains.

CHAPTER 1Sensory Finance

Wandering around inside the average investor's mind is very much like taking a tourist bus around Wonderland with the White Rabbit as a guide. Much that we think is obviously true turns out to be false and much self-evident nonsense is rather closer to reality than we could ever have thought.

We're going to start our tour in a place where everyone can “definitely” tell the difference between truth and falsehood, by looking at the way our senses interact with the world around us. Our ability to interact with the world and to learn from it allows us to extrapolate into the future, to make predictions and then to act on those predictions.

Unfortunately, the skills that serve us so well in everyday life combine to betray us in the topsy-turvy world of investing and finance. Our sensory system may keep us alive, but that's no guarantee it's going to make us rich.