John Nofsinger – Investment Madness

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John Nofsinger – Investment Madness

Why’d you fall for that Internet stock? Why do you always seem to buy high and sell low? Why does it look like everyone else is getting rich but you? As an investor, your emotions are your biggest obstacles — cutting your returns, and raising your risks. Drawing on the new science of behavioral finance, Investment Madness will show you how to take control of your emotions — and maximize your profits. Nofsinger shows how to think about your investments more clearly, without the overconfidence that leads many investors to take too many risks, and lower their returns. You’ll gain insight into how your self-image impacts your investment decisions, and how to recognize when pride or avoiding feelings of regret are preventing you from taking appropriate action. Discover how to place your recent investment experiences — good and bad — in realistic perspective. Learn how to avoid the human tendency to stay with only the financial instruments you’re already comfortable with. Finally, understand how the human brain handles investment memories — and how what you remember may not always be what happened. For every investor, amateur and professional alike.

Editorial Reviews
From the Back Cover
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.

About the Author
DR. JOHN NOFSINGER is a finance professor at Washington State University. His 1997 paper, “Herding and Feedback Trading by Institutional Investors” written with Richard W. Sias, was awarded “Best of the Best” and “Best Paper in Investments” by the Financial Management Association. He has also done advanced research for the New York Stock Exchange and the Association for Investment Management and Research. Nofsinger holds a doctorate from Washington State University.

Excerpt. © Reprinted by permission. All rights reserved.
IntroductionWe 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.

Excerpt. © Reprinted by permission. All rights reserved.
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.

Product details
Publisher ‏ : ‎ Pearson P T R; 1st edition (January 1, 2001)
Language ‏ : ‎ English

About the author

John R. Nofsinger
Dr. Nofsinger is one of the world’s leading experts in behavioral finance. He has authored/coauthored fourteen finance trade books, textbooks, and scholarly books that have been translated into eleven languages. He also a prolific scholar who has published over 70 articles in prestigious scholarly journals and practitioner journals. Dr. Nofsinger is also a frequent speaker on behavioral and financial topics.
Top reviews from the United States

Donald Mitchell
HALL OF FAME
4.0 out of 5 stars Investors Are Overconfident . . . and That’s Costly!
Professor Nofsinger has written the best summary of behavioral finance concerning financial investing that I have seen. Anyone who is thinking about starting out with investing or is dissatisfied with her or his results should read the book. You will save thousands as a result!
Financial thinkers historically assumed that all investors were absolutely rational and logical. Nothing could be further from the truth. Instead, investors misperceive what is going on around them, assume the best, overestimate their competence, and let emotion whipsaw them (brilliantly displayed with a roller coaster illustration in the book). You will read simple, clear summaries of the research that document these flaws.
Here are a few examples. Those who trade the most do the worst. Go on-line, and you will trade more and hurt your returns. People enjoy the validation they get from having been right, so they prefer to sell winners too soon in order to have that experience rather than make the best economic decision (to dump a low-potential loser and get a tax loss) which will make them feel like they have failed. Most people think it is less risky to buy good management. But those stocks have huge downside risk if management stumbles, while those with lousy management have little further downside risk in many cases. The book also takes a great look at the Internet bubble.
My complaint with the book is that it is overconfident in prescribing solutions. Although the suggestions (if followed) should help, most investors will still trail the market averages. Why doesn’t the book make the case for investing in indexed mutual funds? I graded the book down one star for being weak in this area.
The behavioral finance people have done great work in explaining why people do poorly. What they haven’t done is run experiments on how to improve investor behavior. This is like telling people it’s bad to be overweight, and suggesting that they eat less. That won’t lead to weight loss for most people. I hope in the future that Professor Nofsinger will run experiments to find the best ways to help people change their bad habits to better ones. Certainly, his ideas (follow rules of thumb, pay less frequent attention, and quantify your decisions) could potentially help . . . if you can overcome the emotions and misperceptions that drove you to do the wrong thing while feeling comfortable as you did it.
After you read this book, I suggest that you next read John Bogle’s Common Sense on Mutual Funds. Those prescriptions will work better than the ones here for 90 percent of investors, in my experience.
You should also think about where else in your life emotion can cause you to sabotage your self interests. How are effective are you in making economic decisions that affect your family and friends? I suspect that many of these same issues apply in other parts of your life.
Learn to take the right risks . . . to reap greater rewards from the same efforts!

Larry
4.0 out of 5 stars wonderful introduction to behavioral finance
I am the author of two books on investing, and Modern Portfolio Theory. I have become fascinated by the field of behavioral finance and did in fact include a section of it in my second book, What Wall Street Doesn’t Want You to Know. I have read just about everything in this field, as I will have a book to be released in the Spring of 2002 focusing mainly on this subject. This book, along with Why Smart People Make Big Money Mistakes is a wonderful introduction to the field. The stories provided much insights into how we let psychology impact our investment decisions, most often in detrimental ways. I have to disagree with the one reviewer that said the author didn’t provide solutions.While I think he might have been more explicit, I think the reader just missed the points. I would definitely recommend the book

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