Behavioral finance presented here 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 and their benefits - utilitarian, expressive and emotional - 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 want more from our investments than the utilitarian benefits of wealth. We want the expressive and emotional benefits of 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.