Michael M. Pompian - Behavioral Finance and Your Portfolio: A Navigation Guide for Building Wealth

1. Chapter 11
2. Chapter 15

1. Chapter 1
2. Chapter 2
3. Chapter 4
4. Chapter 6
5. Chapter 7
6. Chapter 11
7. Chapter 16
8. Chapter 23
9. Chapter 24
10. Chapter 25
11. Chapter 26
12. Chapter 27
13. Chapter 28
14. Chapter 30
15. Chapter 31
16. Chapter 32

MICHAEL M. POMPIAN

Copyright 2021 by Michael M. Pompian. All rights reserved.

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

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

The charts and information in this presentation are for illustrative purposes only, and are based upon sources of information that Sunpointe, LLC generally considers reliable, however we cannot guarantee, nor have we verified, the accuracy of such independent market information. The charts and information, and the sources utilized in the compilation thereof, are subjective in nature and open to interpretation.

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Library of Congress Cataloging-in-Publication Data

Names: Pompian, Michael M., 1963- author.

Title: Behavioral finance and your portfolio : a navigation guide for building wealth / Michael M. Pompian.

Description: Hoboken, New Jersey : Wiley, [2021] | Includes index.

Identifiers: LCCN 2021008937 (print) | LCCN 2021008938 (ebook) | ISBN 9781119801610 (hardback) | ISBN 9781119802006 (adobe pdf) | ISBN 9781119801993 (epub)

Subjects: LCSH: FinancePsychological aspects. | InvestmentsPsychological aspects. | InvestmentsDecision making.

Classification: LCC HG101 .P658 2021 (print) | LCC HG101 (ebook) | DDC 332.601/9dc23

LC record available at https://lccn.loc.gov/2021008937

LC ebook record available at https://lccn.loc.gov/2021008938

Cover Design: Wiley
Cover Image: sorbetto/DigitalVision Vectors/Getty Images

Founded in 2016, Sunpointe Investments is a wealth management firm that also creates books and articles. Sunpointe is committed to developing first class research and investing content for individuals and financial advisors. Content topics range from portfolio management to behavioral finance and much more.

For a list of article and books, please visit our Web site at www.sunpointeinvestments.com.

This book is dedicated to my three sons Nicholas, Alexander, and Spencer.

If successful, this book will change your idea about what an optimal portfolio is. It is intended to be a guide to both understanding irrational investor behavior and creating portfolios for individual investors that account for these irrational behaviors. In this book, an optimal portfolio lies on the efficient frontier, but may move up or down it depending upon the individual needs and preferences of you as an individual investment decision-maker. When applying behavior finance to real-world investment portfolios, an optimal portfolio is one that an investor can comfortably live with, so that he or she has the ability to adhere to his or her investment program, while at the same time reach long-term financial goals.

Given the run-up in stock prices from 2009, in the wake of the global financial crisis, to 2020, and the bear market brought on by the novel coronavirus, understanding irrational investor behavior is as important as it has ever been. This is true both for the markets in general, but most especially for individual investors. The intended audience for the book is sophisticated individual investors who wish to become more introspective about their own behaviors, and to truly try to understand how to create a portfolio that works for them. The intention is that it is a guidebook, to be used and implemented in the pursuit of building better portfolios. When considering behavioral finance, investors rightly have questions. Some of these are:

• What are the most common investor biases that cause investment mistakes?
• What are the most impactful biases?
• How do I create the best allocation for me, taking into consideration my behavioral tendencies?
• How do I stick to a long-term investment plan?
• Should I buy individual stocks or stick to a diversified portfolio?

This book will answer these questions. There is difference between this book and my prior books. Most of my prior work has been written through the lens of how financial advisors advise: That is, how financial advisors can work better with their clients. This book, however, is written from the point of view of the investor. The only part of the book that has the financial advisor perspective is the case studies at the end. This is intentional. I want you, the investor, to pretend you are an advisor. This way you can implement the lessons in the book, which will drive home the learning.

In the last 25 years, the interest in behavioral finance as a discipline has not simply emerged, but rather exploded onto the scene, with many articles written by very prestigious authors in prestigious publications. We will review some of the key people who have shaped the current body of behavioral finance thinking, and review work done by them. And then the intent is to take the study of behavioral finance to another level: Developing a common understanding (definition) of behavioral biases in terms that advisors and investors can understand, and then demonstrate how they are to be used in practice through the use of case studiesa how-to of behavioral finance. We will also explore some of the new frontiers of behavioral finance, things not even discussed now that may be common knowledge in 25 years.