Investor Behavior Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more. For a list of available titles, visit our website at www.WileyFinance.com. Investor Behavior The Psychology of Financial Planning and Investing Editors H. KENT BAKER VICTOR RICCIARDI Cover design: Wiley Cover image: © Jeffrey Coolidge/Getty Images Copyright © 2014 by John Wiley & Sons, Inc. 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ISBN 978-1-118-49298-7 (cloth); ISBN 978-1-118-72701-0 (ebk); ISBN 978-1-118-72702-7 (ebk) 1. Investments—Psychological aspects. 2. Finance—Psychological aspects. I. Ricciardi, Victor. II. Title. HG4515.15.B34 2014 332.601’9—dc23 2013027577 Contents Acknowledgments xv PArt One Foundations of Investor Behavior ChAPter 1 Investor Behavior: An Overview 3 h. Kent Baker and Victor ricciardi Introduction 3 Organization of the Book 11 Summary 20 References 21 About the Authors 23 ChAPter 2 traditional and Behavioral Finance 25 Lucy F. Ackert Introduction 25 Traditional Finance 26 Behavioral Finance 31 Summary 39 Discussion Questions 39 References 39 About the Author 41 ChAPter 3 Behavioral economics, thinking Processes, Decision-Making, and Investment Behavior 43 Morris Altman Introduction 43 Behavioral Economics, Heuristics, and Decision-Making 44 Investment Heuristics and Investing in Financial Assets 45 The Trust Heuristic and Decision-Making 48 Other Critical Decision-Making Heuristics 49 v vi Contents Rational Investor Decision-Making in a World of Complex Information 56 Summary 58 Discussion Questions 59 References 59 About the Author 61 PArt twO Personal Finance Issues ChAPter 4 Financial Literacy and education 65 Michael S. Finke and Sandra J. huston Introduction 65 Examples of Financial Literacy Measures 68 Financial Literacy and Behavior 71 Financial Literacy Education 75 Summary 77 Discussion Questions 78 References 78 About the Authors 81 ChAPter 5 household Investment Decisions 83 Vicki L. Bogan Introduction 83 Financial Market Participation 83 Market Friction Effects on Household Investment Behavior 85 The Effects of Behavioral Biases on Household Investment Behavior 87 Summary 93 Discussion Questions 94 References 94 About the Author 98 ChAPter 6 Personality traits 99 Lucia Fung and robert B. Durand Introduction 99 A Structural Model of Personality 100 Risk-Taking Behavior 103 Overconfidence 104 Personality and Gender 105 Personality as a Guide for Investors 107 Summary 108 Discussion Questions 109 Contents vii References 109 About the Authors 114 ChAPter 7 Demographic and Socioeconomic Factors of Investors 117 James Farrell Introduction 117 Literature Review 118 Case Study: The Florida Department of Education Employees 122 Summary 131 Discussion Questions 132 References 133 About the Author 134 ChAPter 8 the effect of religion on Financial and Investing Decisions 135 walid Mansour and Mouna Jlassi Introduction 135 Religions and Economic Factors: Dependence or Bifurcation? 136 Religion and Individual Investing Behavior 138 Summary 147 Discussion Questions 147 References 147 About the Authors 151 ChAPter 9 Money and happiness: Implications for Investor Behavior 153 Jing Jian Xiao Introduction 153 Can Money Buy Happiness? 154 Can Happiness Buy Money? 162 Implications for Investor Behavior 164 Summary 165 Discussion Questions 165 References 166 About the Author 169 ChAPter 10 Motivation and Satisfaction 171 Lewis J. Altfest Introduction 171 Classical Economic Motivation 171 Behavioral Economic Motivation 173 Maslow’s Hierarchy of Needs 175 Criticism of Maslow’s Hierarchy of Needs 177 Higher Level Motivation 179 Humanism 181 viii Contents Maslow and Investment Management 182 Personal Finance Integration 183 Summary 185 Discussion Questions 186 References 187 About the Author 188 PArt three Financial Planning Concepts ChAPter 11 Policy-Based Financial Planning: Decision rules for a Changing world 191 Dave Yeske and elissa Buie Introduction 191 Managing Behavioral Biases in the Financial Planning Engagement 194 A Process for Developing Financial Planning Policies 195 Applicability of Financial Planning Policies 199 Policy-Based Financial Planning: The Strategic Perspective 201 Example of Policies Derived through Stochastic Modeling 202 Sample Case Applications 203 Summary 205 Discussion Questions 206 References 206 About the Authors 207 ChAPter 12 Financial Counseling and Coaching 209 John e. Grable and Kristy L. Archuleta Introduction 209 Financial Counseling: A Historical Perspective 210 Theoretical Approaches: A Financial Counseling Perspective 215 Financial Counseling in the Twenty-First Century 221 Summary 223 Discussion Questions 224 References 225 About the Authors 226 ChAPter 13 Financial therapy: De-Biasing and Client Behaviors 227 Joseph w. Goetz and Jerry e. Gale Introduction 227 What Is Financial Therapy? 229 Brief History of Financial Therapy 231 Theoretical Foundations for Financial Therapy 232 The Practice of Financial Therapy 237