BEHAVIORAL FINANCE AND YOUR PORTFOLIO A NAVIGATION GUIDE FOR BUILDING WEALTH 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 permit- ted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior writ- ten 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. 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Classification: LCC HG101 .P658 2021 (print) | LCC HG101 (ebook) | DDC 332.601/9—dc23 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 10 9 8 7 6 5 4 3 2 1 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 individu- als 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. Contents 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 vii viii ConTEnTS 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