Behavioral finance presented in Finance for Normal People is a second generation behavioral finance. The first generation, starting in the early 1980s, largely accepted standard finance’s notion of people’s wants as “rational” wants – restricted to the utilitarian benefits of high returns and low risk. That first generation commonly described people as “irrational” – succumbing to cognitive and emotional errors and misled on their way to their rational wants.
The second generation describes people as normal. It begins by acknowledging the full range of people’s normal wants - hope for riches and freedom from the fear of poverty, nurturing our children and families, being true to our values, gaining high social status, playing games and winning, and more. It distinguishes normal wants from errors, and offers guidance on using shortcuts and avoiding errors on the way to satisfying normal wants. People’s normal wants, even more than their cognitive and emotional shortcuts and errors, underlie answers to important questions of finance, including saving and spending, portfolio construction, asset pricing, and market efficiency. These are presented in this book.
We often hear that behavioral finance is nothing more than a collection of stories about irrational people misled by cognitive and emotional errors, that it lacks the unified structure of standard finance. Yet today's standard finance is no longer unified because wide cracks have opened between its theory and the evidence. This book offers behavioral finance as a unified structure that incorporates parts of standard finance, replaces others, and includes bridges between theory, evidence, and practice.
By Meir Statman read the full article here.
Meir Statman's Finance for Normal People - Book Review
Finance for Normal People: How Investors and Markets Behave by Meir Statman
Finance for Normal People teaches behavioral finance to people like you and me - normal people, neither rational nor irrational. We are consumers, savers, investors, and managers - corporate managers, money managers, financial advisers, and all other financial professionals.
The book guides us to know our wants-including hope for riches, protection from poverty, caring for family, sincere social responsibility and high social status. It teaches financial facts and human behavior, including making cognitive and emotional shortcuts and avoiding cognitive and emotional errors such as overconfidence, hindsight, exaggerated fear, and unrealistic hope. And it guides us to banish ignorance, gain knowledge, and increase the ratio of smart to foolish behavior on our way to what we want.
These lessons of behavioral finance draw on what we know about us-normal people-including our wants, cognition, and emotions. And they draw on the roles of these factors in saving and spending, portfolio construction, returns we can expect from our investments, and whether we can hope to beat the market.
Meir Statman, a founder of behavioral finance, draws on his extensive research and the research of many others to build a unified structure of behavioral finance. Its foundation blocks include normal behavior, behavioral portfolio theory, behavioral life-cycle theory, behavioral asset pricing theory, and behavioral market efficiency.
Review
"As Pogo used to say: 'We have met the enemy and we are it.' By elucidating clearly the teachings of behavioral finance, Meir Statman shows us how to avoid the common errors investors make and how to become smarter investors." - Burton G. Malkiel, author of A Random Walk Down Wall Street, 11th ed. Paper, 2016
"Meir Statman describes investors as normal in this insightful book, not irrational as in earlier behavioral finance, and not rational wealth-maximizing caricatures as in typical textbooks. Normal investors underlie Statman's innovative approach to portfolios, saving and spending, asset pricing, and market efficiency." - Harry Markowitz, Winner, Nobel Prize in Economics, and Professor of Finance at the Rady School of Management
"Meir Statman, a leading light of behavioral finance, describes lucidly and vividly the cognitive and emotional errors underlying the maxim 'If you don't know who you are, the stock market is an expensive place to find out.' Readers of this behaviorally savvy book will be well prepared to avoid those errors." - Paul Slovic, Professor of Psychology, University of Oregon, and author of The Perception of Risk
"One of the pioneers of behavioral finance, Meir Statman has done a great service for investors, portfolio managers, and financial regulators with this insightful volume. If you've ever wondered why you sold too early or why you got in too late, you need to read this book!" - Andrew Lo, Charles E. and Susan T. Harris Professor of Finance, MIT Sloan School of Management
"Yes, to be successful, we need to make good investments, but then we need to be good investors, exhibiting the virtues of simplicity, broad diversification, and low investment costs, and focusing on the long term. This fine book is welcome help." - John C. Bogle, founder of Vanguard and the first index mutual fund
"Finance for Normal People shows that self-knowledge is the most valuable investment skill of all. Meir Statman - one of the founders of Behavioral Finance - uses fascinating new research about market imperfections and the psychology of decision-making to navigate normal people through the complexities of investing. The evidence is compelling and the writing is lucid." - William N. Goetzmann, Edwin J. Beineke Professor of Finance and Management Studies, Yale School of Management
"Meir Statman has pioneered the integration of behavioral research with financial analysis. Finance for Normal People makes the insights of behavioral finance available to the ordinary investors, helping them to understand markets - and themselves." - Baruch Fischhoff, Howard Heinz University Professor, Carnegie Mellon University, and co-author of Risk - A Very Short Introduction
