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Investment Madness: How Psychology Affects Your Investing...and What to Do About It
- By D. Quinn Mills
- Published Jun 21, 2001 by FT Press.
Book
- Sorry, this book is no longer in print.
Description
- Copyright 2002
- Dimensions: F
- Pages: 192
- Edition: 1st
- Book
- ISBN-10: 0-13-042200-2
- ISBN-13: 978-0-13-042200-2
WARNING: Allowing emotion to invade your investment decisions can be hazardous to your wealth.
- Think about your investments more clearly
- How overconfident investors trade too much, take too many risks, and earn lower returns
- The investment impact of your self-image
- Why avoiding feelings of regret now will cause you even greater regrets later
- Yesterday's trade, today's emotions, tomorrow's mistake
- Placing your recent investment experiences in realistic perspective
- The devil you know versus the devil you don't
- Familiarity breeds investment—but not necessarily profit
- Is your memory playing tricks with you?
- You're not alone. We'll tell you what to do about it
- Not all information is alike
- Avoiding herd mentality: your chat room, your brother-in-law, and other temptations. Remember when dotcoms were going to end business as we know it?
How your psychology reduces your profits and increases your risks-and what to do about it!
- Why'd you fall for that Internet stock?
- Why'd you keep money in cash when it could've earned far better returns elsewhere?
- Why haven't you fully funded your retirement plan when you know you should?
- Why do you always seem to buy high and sell low?
- Why does it look like everyone else is getting rich but you?
It's your psychology. It's your emotions. As an investor, they're your biggest obstacles. They cut your returns, and raise your risks. It's about time you did something about it. Investment Madness will show you how. Drawing on the new science of behavioral finance, Dr. John Nofsinger shows you how to:
- See through the "illusion of control" that makes you overconfident about your investments
- Objectively evaluate the stocks and financial instruments you've inherited
- Recognize the feelings of pride, regret, and herd behavior that lead to disaster
- Improve your "mental accounting"—and your portfolio's diversification
With today's instantaneous Internet-based trading, your psychological biases have become more dangerous than ever. Investment Madness delivers expert techniques and mental strategies that will empower you with true self-control—the decisive factor in investment success.
Sample Content
Downloadable Sample Chapter
Click here for a sample chapter for this book: 0130422002.pdf
Table of Contents
INTRODUCTION.
1. Your Behavior Matters!Why haven't I Heard of This Before? A simple Illustration. Prediction. Behavioral Finance. The Investment Environment. Endnotes.
I. NOT THINKING CLEARLY.
2. Overconfidence.Becoming Overconfident. Illusion of knowledge. Illusion of Control. Recipe for Disaster? Endnotes.
3. Overconfidence and Investing.Overconfidence: A Case Study I. Overconfidence and Trade Frequency. Gender Differences. Trading Too Much. Overconfidence and Risk. Overconfidence and Experience. Mutual Funds. Overconfidence and the Internet. Summing Up. Endnotes.
4. Status Quo - Or What I Own Is Better!Endowment Effect. Endowment and Investing. Status Quo Bias. Attachment Bias. Overcoming These Biases. Endnotes.
II. EMOTIONS RULE.
5. Seeking Pride and Avoiding Regret.Disposition Effect. Do We Really Sell Winners? Selling Winners Too Soon and Holding Losers Too Long. The Disposition Effect and the Media. Avoiding the Avoiding of Regret. In Summary. Endnotes.
6. Double or Nothing.House Money Effect. Snake-Bit (Risk Aversion) Effect. Break-Even Effect. Would You Buy This IPO? The Tech Bubble. Endnotes.
7. Social Aspects of Investing.Sharing Investment Knowledge. Moving with the Hotel. Speed Is of the Essence (Not). Investment Clubs. Beardstown Ladies. Investment Club Performance. Investment Club and Social Dynamics. Summing Up. Endnotes.
III. FUNCTIONING OF THE BRAIN.
8. Mental Accounting.Mental Budgeting. Matching Costs to Benefits. Aversion to Debt. Sunk-Cost Effect. Economic Impact. Mental Accounting and Investing. Endnotes.
9. Mental Accounting and Diversification.Mental Accounting and Portfolios. Risk Perceptions. Risk Perception in the Real World. Building Behavioral Portfolios. Summing Up. Endnotes.
10. That's Not the Way I Remember It.Memory and Investment Decisions. Cognitive Dissonance. Cognitive Dissonance and Investing. Cognitive Dissonance and the Steadman Funds. Memory and Socialization. Reference Points. Summing Up. Endnotes.
11. What I Know Is Better.Representativeness. Representativeness and Investing. Familiarity. Familiarity Breeds Investment. Familiarity Breeds Investment Problems. Endnotes.
IV. INVESTING AND THE INTERNET.
12. The Internet (Psycho) Investor.The Rise of the Internet Investor. Amplifying Psychological Biases. Information and Control. Online Trading and Overconfidence. Advertising - Increasing the Biases. Online Trading and Performance. Day Traders - The Extreme Case. Summing Up. Endnotes.
13. Exuberance on (and about) the Net.A Rose.com by Any Other Name. A Bubble Burst. The More Things Change. The Boiler Room Goes Online. Endnotes.
V. WHAT CAN I DO ABOUT IT?
14. Self-Control, or the Lack of It!Short-Term versus Long-Term Focus. Controlling Oursleves. Rules of Thumb. Environment Control. Self-Control and Saving. IRA's. 401 (k) Plans. Self-Control and Investing. Self-Control and Dividends. Summing Up. Endnotes.
15. Battling Your Biases.Strategy 1: Understand Your Psychological Biases. Not Thinking Clearly. Letting Emotions Rule. Functioning of the Brain. Strategy 2: Know Why You are Investing. Strategy 3: Have Quantitative. Investment Criteria. Strategy 4: Diversify. Strategy 5: Control Your Investing. Environment. Additional Rules of Thumb. In Conclusion.
Index.Preface
Introduction
We are all prone to having psychological preconceptions or biases that make us behave in certain ways. These biases influence how we assimilate the information we come in contact with on a daily basis. They also have an impact on how we utilize that information to make decisions.
Some of the decisions that are influenced by our psychological biases can have a large impact on our personal wealth - or the lack of it. I have written this book to try to show you how your own psychological biases can creep into your investment decisions and sabotage your attempts at building wealth.
WHAT TO EXPECT FROM THIS BOOK
There are five parts in this book. The first three parts illustrate different psychological biases that affect our daily lives. The chapters in these parts are structured so they are similar to each other. First, I identify the psychological trait and explain using common, daily activities. Then I examine the degree to which investors are affected by the bias. Part 4 demonstrates how the Internet exacerbates these psychological problems. Finally, the chapters in Part 5 describe what investors can do to help themselves.
The chapters in Part 1, "Not Thinking Clearly," demonstrate how investment decision making is not always rational. As you will see, people set their range of possible outcomes too narrowly. This is part of a broader problem called overconfidence. Overconfident investors trade too much, take too much risk, and earn lower returns. This topic is discussed in Chapter 2 and 3. If overconfidence causes investors to act too frequently, other biases described in Chapter 4 causes investors to fail to act when they should.
Part 2, "Emotions Rule," shows how the emotions associated with investing affect our decisions. Chapter 5 illustrates how an investor's view of himself causes him to avoid feelings of regret and to seek pride. Consequently, investors sell winner stocks too soon and hold onto loser stocks too long. Chapter 6 demonstrates that your past failures and successes have a dramatic impact on your current decision making process. Lastly, our emotional state is often affected by the social aspects of investing; we discuss this in Chapter 7.
The third part, "Functioning of the Brain," shows how the human brain's processes for interpreting and remembering information affect investors. For example, every day you are bombarded by information. The brain uses a process called mental accounting to store and keep track of important decisions and outcomes. Chapter 8 shows that as a consequence of this process, people make poor financial decisions. Discussed in Chapter 9 is one particularly important implication of how investors view portfolio diversification. The brain also uses shortcuts to quickly process information. This leads to impacts on investor memory (Chapter 10) and the problem of representativeness and familiarity (Chapter 11).
Part 4, "Investing and the Internet," discusses the interaction among the Internet, psychology, and investing. The Internet allows investors quick access to information, trading, and other investors' opinions. However, these attributes actually magnify the psychological biases. These issues are addressed in Chapters 12 and 13.
Finally, part 5, "What Can I Do About It?" discusses what the investor can do to avoid these psychological biases. The difficulty of maintaining self-control in the face of the psychological biases is illustrated in Chapter 14. The last chapter shows that planning, incentives, and rules of thumb are helpful in avoiding the common problems.