Investing 101: Updated and Expanded

Chapter 1. FIXING MONEY PROBLEMS

When I started writing about fnance, the world according to Wall Street was promoting something called the "efficient markets theory." In a nutshell, this theory contends that the day-to-day price movements of stocks and bonds are ultimately rational—based on investors making informed and savvy choices about what to do with their cash at any given moment of the day. The idea was that we all went into the investment markets with a fist full of cash and all the accurate information we'd need. Then, our conversations would go something like this: "Hmm, that stock is a bargain at this price: Buy! Those bonds aren't yielding enough: Sell and redeploy our capital!" As the market moved to reflect the increasing demand on the savviest investments and the dearth of buyers for the less attractive investments, the prices would shift accordingly and investors would make new choices. Supply and demand are always in sync and investors are always rational.

The bulk of the world has now recognized this controversial theory to be largely irrelevant to individual investors.

It's not that people never make rational decisions about their money. They do—just not all the time and not even when taken as a group. Wall Street's favorite theory is now "behavioral fnance." This theory explains why smart people often make dumb decisions about their money.

The great thing about this shift is that behavioral finance is something we all can relate to. We know instinctively—or from ...