Behavioral Finance and Your Portfolio A Navigation Guide for Building Wealth

Become a more strategic and successful investor by identifying the biases impacting your decision making.

In Behavioral Finance and Your Portfolio, acclaimed investment advisor and author Michael M. Pompian delivers an insightful and thorough guide to countering the negative effect of cognitive and behavioral biases on your financial decisions. You’ll learn about the “Big Five” behavioral biases and how they’re reducing your returns and leading to unwanted and unnecessary costs in your portfolio.

Designed for investors who are serious about maximizing their gains, in this book you’ll discover how to:

● Take control of your decision-making—even when challenging markets push greed and fear to intolerable levels

● Reflect on how to make investment decisions using data-backed and substantiated information instead of emotion and bias

● Counter deep-seated biases like loss aversion, hindsight and overconfidence with self-awareness and hard facts

● Identify your personal investment psychology profile, which you can use  to inform your future financial decision making

Behavioral Finance and Your Portfolio was created for individual investors, but will also earn a place in the libraries of financial advisors, planners and portfolio managers who are determined to counteract the less principled and data-driven aspects of their decision making.

Michael M. Pompian, CFA, CFP, CAIA, is the Founder and Chief Investment Officer of Sunpointe Investments, a multi-family office investment firm in St. Louis, Missouri.  He was formerly a Partner at Mercer Investment Consulting for 10 years and was the National Segment Leader for the private wealth business where he consulted to the firm's largest family office clients, overseeing $8 billion. Prior to joining Mercer, Michael was a Wealth Management Advisor with Merrill Lynch and a private banker with PNC Private Bank. Prior to these positions, Michael was on the investment staff of a family office. Michael earned his MBA in Finance from Tulane University and graduated from the University of New Hampshire with a BS degree in Management. Michael has written four books: Advising Ultra Affluent Clients and Family Offices (Wiley 2009), Behavioral Finance and Wealth Management (Wiley 2006), Behavioral Finance and Wealth Management, 2nd Edition (Wiley 2012) and Behavioral Investor Types (Wiley 2015). He writes a monthly column for Morningstar Advisor and has been quoted in Money Magazine, The New York Times, Bloomberg, CNBC among other media outlets. Michael holds the Chartered Financial Analyst (CFA), Chartered Alternative Investment Analyst (CAIA), Certified Financial Planner (CFP®) and Certified Trust Financial Advisor (CTFA). He is a member of the CFA Institute, the New York Society of Securities Analysts (NYSSA) and the CFA Society of St. Louis. He is a regular speaker at family office conferences globally.

Preface xv

Acknowledgments xxi

About the Author xxiii

Part I Introduction To Behavioral Finance 1

Chapter 1: What is Behavioral Finance and Why Does It Matter? 3

Why Behavioral Finance Matters 5

Behavioral Finance: The Big Picture 6

Standard Finance versus Behavioral Finance 15

Chapter 2: Introduction to Behavioral Biases 23

Introduction 23

Behavioral Biases Defined 24

Why Understanding and Identifying Behavioral Biases is Crucial 25

Categorization of Behavioral Biases 27

Differences between Cognitive and Emotional Biases 27

Difference among Cognitive Biases 28

Emotional Biases 29

A Final Word on Biases 31

Part II Belief Perseverance Biases Defined and Illustrated 33

Chapter 3: Belief Perseverance Bias #1: Cognitive Dissonance Bias 35

Bias Description 35

Am I Subject to Cognitive Dissonance Bias? 38

Investment Advice 39

Chapter 4: Belief Perseverance Bias #2: Conservatism Bias 41

Bias Description 41

Am I Subject to Conservatism Bias? 44

Investment Advice 45

Chapter 5: Belief Perseverance Bias #3: Confirmation Bias 47

Bias Description 47

Am I Subject to Confirmation Bias? 51

Investment Advice 52

Chapter 6: Belief Perseverance Bias #4: Representativeness Bias 55

Bias Description 55

Examples of Representativeness Bias 56

Am I Subject to Representativeness Bias? 60

Investment Advice 62

Chapter 7: Belief Perseverance Bias #5: Illusion-of-Control Bias 65

Bias Description 65

Example of Illusion of Control Bias 66

Am I Subject to Illusion of Control Bias? 69

Investment Advice 70

Chapter 8: Belief Perseverance Bias #6: Hindsight Bias 73

Bias Description 73

Example of Hindsight Bias 74

Am I Subject to Hindsight Bias? 76

Investment Advice 77

Part III: Information Processing Biases Defined and Illustrated 79

Chapter 9: Information Processing Bias #1: Mental Accounting Bias 81

Bias Description 81

Practical Application 83

Am I Subject to Mental Accounting Bias? 85

Investment Advice 88

Chapter 10: Information Processing Bias #2: Anchoring Bias 91

Bias Description 91

Example of Anchoring and Bias 92

Am I Subject to Anchoring Bias? 94

Investment Advice 95

Bonus Discussion: Investment Strategies That Leverage Anchoring Bias 96

Chapter 11: Information Processing Bias #3: Framing Bias 99

Bias Description 99

Example of Framing Bias 101

Am I Subject to Framing Bias? 105

Investment Advice 107

Chapter 12: Information Processing Bias #4: Availability Bias 109

Bias Description 109

Example of Availability Bias 110

Am I Subject to Availability Bias? 113

Investment Advice 114

Chapter 13: Information Processing Bias #5: Self-Attribution Bias 117

Bias Description 117

Example of Self-Attribution Bias 118

Am I Subject to Self-Attribution Bias? 119

Investment Advice 121

Chapter 14: Information Processing Bias #6: Outcome Bias 123

Bias Description 123

Am I Subject to Recency Bias? 125

Chapter 15: Information Processing Bias #7: Recency Bias 129

Bias Description 129

Example of Recency Bias 130

Am I Subject to Recency Bias? 134

Investment Advice 135

Part IV: Emotional Biases Defined and Illustrated 137

Chapter 16: Emotional Bias #1: Loss Aversion Bias 139

Bias Description 139

Example of Loss Aversion Bias 140

Am I Subject to Loss Aversion Bias? 142

Investment Advice 144

Chapter 17: Emotional Bias #2: Overconfidence Bias 145

Bias Description 145

Examples of Overconfidence Bias 146

Am I Subject to Overconfidence Bias? 148

Investment Advice 151

A Final Word on Overconfidence 153

Chapter 18: Emotional Bias #3: Self-Control Bias 155

Bias Description 155

Example of Self-Control Bias 156

Am I Subject to Self-Control Bias? 159

Investment Advice 160

Chapter 19: Emotional Bias #4: Status Quo Bias 163

Bias Description 163

Example of Status Quo Bias 164

Am I Subject to Status Quo Bias? 165

Investment Advice 167

Chapter 20: Emotional Bias #5: Endowment Bias 169

Bias Description 169

Example of Endowment Bias 170

Am I Subject to Endowment Bias? 172

Investment Advice 173

Chapter 21: Emotional Bias #6: Regret Aversion Bias 175

Bias Description 175

Example of Regret Bias 176

Am I Subject to Regret Bias? 179

Advice 180

Chapter 22: Emotional Bias #7: Affinity Bias 183

Bias Description 183

Example of Affinity Bias 184

Am I Subject to Affinity Bias? 186

Investment Advice 188

Part V: Behavioral Investor Types 189

Chapter 23: Staying on Target to Reach Financial Goals is Hard 191

Non-Financial Examples of

Self-Defeating Behavior 192

Financial Examples of Self-Defeating Behavior 196

Chapter 24: Introduction to Behavioral Investor Types 201

Introduction 201

What is My Behavioral Investor Type? 204

Step 1: BIT Orientation Quiz 205

Step 2: Bias Identification Quiz 210

Step 3: Advice for Each BIT 216

Summary 216

Chapter 25: Preserver Behavioral Investor Type 217

Upside/Downside Analysis 219

Bias Analysis of Preservers 220

Advice for Preservers 224

Chapter 26: Follower Behavioral Investor Type 225

Upside/Downside Analysis 227

Bias Analysis of Followers 228

Other Important Follower Biases: Hindsight, Cognitive Dissonance and Regret 232

Advice for Followers 233

Chapter 27: Independent Behavioral Investor Type 235

Upside/Downside Analysis 237

Bias Analysis of Independents 238

Self-Attribution 240

Conservatism Bias 241

Representative Bias 242

Advice for Independents 242

Chapter 28: Accumulator Behavioral Investor Type 243

Upside/Downside Analysis 245

Accumulator Bias Analysis 246

Advice for Accumulators 251

Chapter 29: Asset Allocation Case Studies for Each Behavioral Investor Type 253

Part VI: Behavioral Aspects of Portfolio Implementation 271

Chapter 30: Behavioral Finance Aspects of the Active versus Passive Debate 273

The Logic of Passive Management 274

The Potential Benefits of Active Management 274

Advice: Use the Best Practical Allocation for Your Portfolio 277

Chapter 31: Behaviorally Aware Portfolio Construction 279

Introduction 279

Goals-based Investing 280

Consolidating Accounts into a Portfolio View 281

Portfolio Approach 282

Chapter 32: Behavioral Finance and Market Corrections 285

The Most Recent Panic 286

Index 291

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