A Great New Book On Behavioral InvestingAdvisor Perspectives
I recently provided a baker’s dozen list of my favorite books on behavioral finance. Having just finished reading Daniel Crosby’s The Behavioral Investor (available from the Amazon link on this page), my list of favorites has now expanded to 14.
Behavioral finance is the study of human behavior and how it leads to investment errors, including the mispricing of assets. Research in the field has provided many useful insights regarding judgment errors investors make that undermine their results, helping us understand why we make decisions the way we do and providing us with clues as to how we should invest. This is one reason that Princeton psychology professor Daniel Kahneman was awarded the Nobel Memorial Prize in Economic Sciences in 2002.
The field has gained an increasing amount of attention in academia over the past several decades as pricing anomalies have been discovered. The basic hypothesis of behavioral finance is that, due to behavioral biases, investors/markets make persistent mistakes in pricing securities. An example of a persistent mistake is that investors/the market underreacts to news – both good and bad news are only slowly incorporated into prices, creating momentum.
Because behavioral finance is my favorite subject, I read everything I can get my hands on. And it’s why I wrote Investment Mistakes Even Smart Investors Make and How to Avoid Them, which covers 77 mistakes, most of which are related to behavioral errors (others are simply due to lack of knowledge).
Crosby begins with a look at the sociological difficulties surrounding investment decision-making. He then examines how the brain and body are poorly matched to the task of managing investments. He proceeds to investigate the behavioral tendencies investors exhibit.
Crosby provides many great examples that help us understand how and why we act against our self-interest – though much of the financial media and Wall Street are not far behind. The following, from a study by John Coates, a former trader turned neurologist, provides great insights about the time-varying nature of how we deal with risk as well as why. In a June 7, 2014, New York Times article, “The Biology of Risk”, Coates explained: “Most of us tend to believe that stress is largely a psychological phenomenon, a state of being upset because something nasty happened. But if you want to understand stress you must disabuse yourself of that view. The stress response is largely physical: It is your body priming itself for impending movement.”
Read the full article here by Larry Swedroe, Advisor Perspectives