From the January 01, 2007 issue of Futures Magazine • Subscribe!

Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor

By Michael M. Pompian

John Wiley Sons Inc., 2006

317 pages, $60

By Reviewer Leslie N. Masonson

There have been numerous research projects conducted on investor behavior and one universal finding is that many investors act against their own interests. Investors invariably buy high and sell low, or sell their winners and hold their losers.

If investors and traders, can avoid their foibles, their investment results would improve.

He provides a history of behavioral finance including the pioneers in the field and their contributions, as well as a description of how behavioral finance can be used to improve upon the standard asset allocation process. His goal is to have readers change their idea about the composition of an optimal portfolio, and understand their own irrational behaviors by taking them into account and avoiding them.

The book describes major investor biases including regret aversion, loss aversion and anchoring and cognitive dissonance, which negatively affect investment performance. He then covers each bias with a general technical description; practical application and investor implications; research papers that provide insight into the bias; diagnostic test questions for reader to detect bias; and advice on how investors can deal with bias.

Three cases studies are provided that bring home the author’s key points. In each case, Pompian provides a sample portfolio that fits the personality of each investor. In addition, there is a fascinating chapter on gender, personality type and investor behavior showing the difference in risk tolerance between men and women.

There is a chapter on investor personality types where readers can determine their own profile and how to best handle their own personality. This is very useful and most readers would benefit from this short exercise.

For financial professionals, investors, and traders interested in delving into behavioral finance and portfolio selection, Pompian offers solid advice on the subject, coupled with prior research findings. The structured chapter format used to illustrate the biases makes it easy to compare and contrast them.

Leslie N. Masonson is president of Cash Management Resources, a financial consulting firm, and the author of All About Market Timing and Day Trading on the Edge. E-mail: lesmason@frontiernet.net.

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