As you might imagine, people send me more books to review than I can possibly read. And, truthfully, despite their hype, many don’t offer much in the way of useful information for advisors. Occasionally, though, I’ll get an email from a publisher about a new book that looks interesting. This was the case with “Investor Behavior: The Psychology of Financial Planning and Investing,” a collection of articles compiled by H. Kent Baker, professor of finance at American University’s Kogod School of Business, and Victor Ricciardi, assistant professor of financial management at Goucher College.
My interest was piqued by my long fascination with the relatively new discipline of behavioral finance and its even newer cousin, behavioral economics. For those who have been in a coma for the past 20 years, back in the late 1980s, some economists became uncomfortable with the general economic assumption that people tend to act rationally when it comes to their finances. (I know, financial planners have been aware of this fallacy since the early ‘70s; academics tend to catch on more slowly.) Some of them thought it might be interesting to study what investors actually do in given situations; when it turned out that most of us are far less rational than previously thought, a new area of study was born.
Sensing that the fruits of this research could yield valuable insights into how financial advisors might work with their clients more effectively, I’ve tried to keep up with the new research. Some insights have indeed been useful, such as programs like those offered by Loring Ward (see “My Conversation With Harry Markowitz: MPT and Behavioral Economics”). Yet I’ve been largely disappointed that behavioral finance hasn’t been able to tell advisors more about how clients think. My hope was that Baker and Ricciardi’s book would fill that gap.
Toward that end, I have to admit to being somewhat disappointed. Out of some 30 articles by different authors, only a couple deliver information tailored for use by practicing advisors: “Policy-Based Financial Planning: Decision Rules for a Changing World” by Dave Yeske, managing director, and Elisa Buie, CEO of Yeske Buie; and “Advising the Behavioral Investor: Lessons from the Real World” by Gregg Fisher, founder of Gerstein Fisher. There’s also a good piece by Joseph Rizzi, president of Macro Strategies LLC, called “Post-Crisis Investor Behavior: Experience Matters,” which talks about how the experience of 2008-2009 shaped the investing tendencies of Gen Y.
With that said, this is by far the hardest book review I’ve ever written. I keep finding articles that, while not directly applicable to financial advice, are too interesting not to read. For instance, I had to pry myself away from reading about the emerging profession of financial counseling, only to get sucked into the socio-economic roots and implications of behavioral economics for another 20 minutes.
Then, under the premise that veteran financial planner Lew Altfest surely would offer some nuggets for his brethren advisors, I started reading his chapter, “Motivation and Satisfaction.” Instead, Altfest combined Modigliani’s “life cycles” and Maslow’s hierarchy of human needs with the “humanism” of Lutz (conflicting desires and developing a meaningful life) and Heylighen (self-actualization) to lay a theoretical foundation for the “life planning” movement of George Kinder and others. Interesting to be sure (it cost me 50 minutes), but a bit pointy-headed for most of the financial advisors I know.
I resolved to focus my efforts on the advisor-centered chapters of “Investor Behavior” when the book fell open to “The Surprising Real World of Traders’ Psychology” in which Denise Shull of The ReThink Group Inc. and trading psychologists Ken Celiano and Andres Menaker combined “social brain theory” with neurochemistry, human physiology, Freudian psychology and fractal theory to explore the effects of securities traders’ unconscious minds on their “judgment, skills and behavior” while making trades. The two case studies they cited to support their conclusions are must-reads for anyone who manages investment portfolios.
As for the articles that will actually help advisors in their client work, Rizzi’s article highlights research that confirms the existence of generational biases that have been shaped by economic events: “The financial crisis of 2008-2009 with its 50% drop in stock market value is seared into the collective investor memory—especially generation Y investors,” he wrote. “[Younger] investors are more focused on reacting to macro developments than asset fundamentals. The shift from ‘return on capital’ to ‘return of capital’ underlies the move away from equities into perceived lower risk fixed income by certain investor groups.”
Did you get that? Those “Gen Y investors” that everyone is so breathlessly talking about attracting as clients are likely to be the most risk-phobic generation since my parents’, which lived through the Great Depression of the 1930s.