This chapter is written as a narrative to make it easier to under-
stand the basic research and issues of behavioral finance. Dave is an in-
vestor who falls into psychological traps that prevent him from being
effective. You may notice similarities between his behavior and your
own. If so, the advice given in this chapter should help the reader be-
come a more successful investor. Dave first talks to his wife Jennifer and
then to an Investment Counselor who understands behavioral finance.
The narrative begins in the fall of 1999, several months prior to the peak
in the technology and Internet bubble that dominated markets at the
turn of the century.
THE TECHNOLOGY BUBBLE, 1999 TO 2001
TIME:OCTOBER 1999
Dave:Jen, I’ve made some important investment decisions. Our portfo-
lio contains nothing but these “old fogy” stocks like Philip Morris, Proc-
ter & Gamble, and Exxon. These stocks just aren’t doing anything right
now. My friends Bob and Paul at work have been making a fortune in In-
ternet stocks. I talked with my broker, Allan, about the prospects of these
stocks. He said the experts think the Internet is the wave of the future.
I’m selling some of our stocks that just aren’t moving and getting into
the Internet stocks like Amazon, Yahoo!, and Inktomi.
Jennifer:I’ve heard that those stocks are very speculative. Are you sure
you know what you’re doing?
Dave:Allan says that we are entering a “New Economy,” spurred by a
communications revolution that is going to completely change the way
we do business. Those stocks that we owned are Old Economy stocks.
They had their time, but we should be investing for the future. I know
these Internet stocks are volatile, and I’ll watch them very carefully so
we won’t lose money. Trust me. I think we’re finally on the right track.
TIME:MARCH 2000
Dave:Jen, have you seen our latest financial statements? We’re up 60
percent since October. The Nasdaq crossed 5,000, and no one I’ve heard
believes it will stop there. The excitement about the market is spreading,
and it has become thetopic of conversation around the office.
Jen:You seem to be trading in and out of stocks a lot more than you did
before. I can’t follow what we own!
Dave:Information is hitting the market faster and faster. I have to con-
tinuously adjust my portfolio. Commissions are so cheap now that it
320 PART 4 Stock Fluctuations in the Short Run