Investor Behavior: The Psychology of Financial Planning and Investing

Acknowledgments xv

Part One - Foundations of Investor Behavior

Chapter 1 - Investor Behavior: AnOverview 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