Decided to post prior notes on books I have read in the past 12 months.
Jason Zweig, “Your Money & Your Brain,” (How the new science of Neuroeconmics Can Help Make You Rich) Simon & Schuster, 2007
As you can determine in the picture, Leo was very surprised when I told him this was a good book; his expression says it all. Anyway, here are the notes he and I put together.
What happens inside our brains when we think about Money? Quite a lot and some of it is not good for our financial health. In this book, Jason Zweig explains why smart people make stupid financial decisions—and what they can do to avoid these mistakes. Zweig, a veteran financial journalist, draws on the latest research in neuroeconomics, a new discipline that combines psychology, neuroscience, and economics to better understand financial decision making. He shows why we often misunderstand risk and why we tend to be overconfident about our investment decisions. This book offers some radical new insights into investing and shows investors how to take control of the battlefield between reason and emotion. In the course of his research, Zweig visited leading neurosicience laboratories and subjected himself to numerous experiments. He blends anecdotes from these experiences with stories about investing mistakes, including confessions of stupidity from some highly successful people. Then he draws lessons and offers original practical steps that investors can take to make wiser decisions.
My Notes:
Pg. 1: Neuroeconomics: a hybrid of neuroscience, economics, and psychology. Through this we can begin to understand what drives investing behavior not only on the theoretical or practical level, but as a basic biological function. Economists have long insisted that investors know what they want, understand the tradeoff between risk and reward, and use information logically to pursue their goals. In practice those assumptions often turn out to be dead wrong.
Pg. 3: One of the themes of this book is that our investing brains often drive us to do things that make no logical sense—but make perfect emotional sense. That does not make us irrational. It makes us human. Our brains were originally designed to get more of whatever would improve our odds of survival and to avoid whatever would worsen the odds. Emotional circuits deep in our brains make us instinctively crave whatever feels likely to be rewarding—and shun whatever seems liable to be risky. To counteract these impulses from cells that originally developed tens of millions of years ago, your brain has only a thin veneer of relatively modern, analytical circuits that are often no match for the blunt emotional power of the most ancient parts of your mind. That’s why knowing the right answer, and doing the right thing, are very different.
Pg. 4: In the 1950’s, a young researcher at the RAND Corporation was pondering how much of his retirement fund to allocate to stocks and how much to bonds. An expert in linear programming, he knew that “I should have computed the historical co-variances of the asset classes and drawn an efficient frontier. Instead, I visualized my grief if the stock market went way up and I wasn’t in it—or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities.” The researcher’s name was Harry M. Markowitz. Several years earlier, he had written an article called “Portfolio Selection” for the Journal of Finance showing exactly how to calculate the tradeoff between risk and return. In 1990, Markowitz shared the Nobel Prize in economics, largely for the mathematical breakthrough that he had been incapable of applying to his own portfolio.
Pg. 13: Most financial decisions are a tug of war between analytical and intuitive thinking (reflective vs reflexive). We run mostly on our reflexive system which has phenomenal skill in recognizing similarities, and sounds an instant alarm when it detects a difference.
Pg. 23: Decades of rigorous research have proven that the single most critical factor in the future performance of a mutual fund is its fees and expenses. (other critical factors are diversification, and rebalancing [buy low, sell high]).
Skip hedge funds entirely and rule out any mutual fund with annual expenses higher than these thresholds:
· Government bond funds: 0.75%
· U.S. stock funds: 1.0%
· Small-stock our high-yield bond funds: 1.25%
· International-stock funds: 1.5%
Pg. 56: It took two psychologists, Daniel Kahneman and Amos Tversky, to deal a death blow to the traditional view that people are always “rational.” In economic theory, we process all the relevant information in a logical way to figure out which choice offers the best tradeoff between risk and return. In reality, Kahneman and Tversky showed, people tend to base their prediction of long-term trends on surprisingly short-term samples of data—or on factors that are not even relevant.
Pg. 61: For nearly our entire history as a species, humans were hunter-gatherers, living in small nomadic bands, seeking mates, finding shelter, pursuing prey and avoiding predators, foraging for edible fruits, seeds, and roots. For our earliest ancestors, decisions were fewer and less complex: Avoid the places where leopards lurk. Learn the hints of coming rainfall, the clues of antelope just over the horizon, the signs of fresh water nearby. Understand who is trustworthy, figure out how to collaborate with them, learn how to outsmart those who are not. Those are the kinds of tasks our brains evolved to perform. Our own advanced species, Homo sapiens, is less than 200,000 years old and the human brain has barely grown since then.
Pg. 65: Just as nature abhors a vacuum, people hate randomness. The human compulsion to make predictions about the unpredictable originates in the dopamine centers of the reflexive brain. Zweig calls this human tendency “the prediction addiction.”
Pg. 71: The biggest investors on earth fall just as hard for the “three’s a trend” fallacy. A recent study of the hiring and firing of money managers by pension funds, endowments, and foundations found that these “sophisticated investors” consistently hire firms that are on a three-year hot streak. They also fire money managers that are on a three-year cold streak. Ironically, the firms they hire go on to underperform the market, while the firms they fire end up outperforming. These so-called experts who run the world’s largest investment pools would earn much better returns if, rather than going by the “three’s a trend” fallacy, they froze their portfolios in place and did absolutely nothing.
Pg. 110: In the waning days of the Soviet empire, when history textbooks were constantly being rewritten to cover one disgrace or another, dissidents in Eastern Europe used to joke that the past was as difficult to predict as the future. Despite the common cliché, hindsight is not 20/20. Once we learn what did happen, we look back and believe that we knew it was going to happen all along—even if we were utterly in the dark at the time. That’s what psychologists call “hindsight bias.” Psychologist Baruch Fischoff explains this: “When you hear something you immediately incorporate it into what you already know. That seems like a more efficient and sensible thing to do than trying to put new information into some kind of intellectual limbo, waiting until it proves itself before you can use it. But it’s not particularly helpful if you want to go back and figure out what was the extent of your knowledge and what is your ability to predict things.” Hindsight bias makes surprises vanish,” says psychologist Daniel Kahneman. “People distort and misremember what they formerly believed. Our sense of how uncertain the world really is never fully develops, because after something happens, we greatly increase our judgments of how likely it was to happen.” Hindsight bias is another cruel trick your inner con man plays on you. By making you believe that the past was more predictable than it really was, hindsight bias fools you into thinking that the future is more predictable than it can ever be. That keeps you from feeling like an idiot as you look back—but it can make you act like an idiot as you go forward.
Pg. 129: The practice of determining an investors tolerance for risk: The first problem with these questionnaires is that they assume you already know how much risk you are comfortable with. Secondly they are inconsistent. When 113 business students filled out risk-tolerance quizzes from six major financial companies, the average similarity among the results was only 56%. In other words, the odds that any two questionnaires would conclude the same person had the same risk profile were barely better than the flip of a coin. Your supposed level of risk tolerance may depend less on who you are than on whose quiz you happen to take. But there’s a more basic issue here. Does any of us really have a single level of “risk tolerance” that can be measured as precisely as our shoe size? Among the countless dumb ideas pervading the investment industry, this may be the dumbest of all. To an astonishing degree, how much risk you can stand depends on what mood you happen to be in.
Pg. 194: A recent study of the accounts held by 1.2 million 401(k) investors found that 79% never shifted a dime from one fund to another in 2003 or 2004 even as the stock market gained more than 40%. A 1986 study examined the decisions of 850,000 people saving for retirement through the TIAA-CREF pension system. Over the course of their investing lifetimes, 72% of the participants never made a single asset-allocation change; they always invested in exactly the same funds they chose at the beginning.
That's all folks.
Grampa John and Leo and Sophie
No comments:
Post a Comment