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Why Smart People Make Big Money Mistakes

I have just finished a fascinating book, Why Smart People Make Big Money Mistakes by Gary Belsky and Thomas Gilovich. Traditional economics considers people as rational being, acting to optimize one's own welfare. In practice, few people really acting rationally all the time. Even well informed people have found to make many faulted financial decisions. Behavioral economics incorporates psychology and cognitive factor into consideration. It have found great insight into people decision making process.

Below are simply my notes taken from the book.

Ch.1 Mental Accounting, Richard Thaler. Statistical Regression, Sir Francis Galton, 1911 (tendency to fall back into statistical mean).

Ch.2 Prospect Theory, Daniel Kahneman, Amos Tversky, 1979. (Issue framing, e.g. loss aversion, sunk cost fallacy).

Ch.3 The Devil That You Know

Decision Paralysis - tendencies to avoid or delay action, particularly due to the fear of regret and a preference for the familiar.

  • Maximizer/Satisfier - Herbert Simon, 1950s.
  • Trade off contrast - choices are enhanced or hindered by the tradeoff between options, even for options we wouldn't choose anyway, Tversky, Simonson.
  • Extremeness aversion - people are more likely to choose an option if it is an intermediate choice within a group, Tversky, Simonson. (so it can be manipulated by introducing extreme choice).
  • Status quo basis, endowment effect - preference for holding on what you have.
  • Regret aversion - avoid the pain of regret and the responsibility for negative outcomes.

Counter Measures

  • Take opportunity cost into account
  • Mark Twain's saying, "Twenty Years from now you will be more disappointed by the things you didn't do than by the ones you did do."

Ch.4 Number Numbness

  • Neglecting the base rate - tendency to disregard or discount overall odds, Kahneman, Tversky.

Ch.5 Dropping Anchor

  • Anchoring - clinging to a fact or figure or idea that may or may not have any real relevance to your judgment or decision.
  • Confirmation bias/Preferential bias - once people developed bias, they tend to view new information in such a way that it supports those preferences (Edward Russo).

Ch.6 The Ego Trap

The tendency to attribute success to your ability but to attribute failure to other causes.

  • Heads I win, tails it's chance, Eileen Langer, 1975
  • "Expert" predicition, Tetlock
  • "Hindsight bias", Baruch Fischhoff

2010.05.27 [, ] - comments

 

Stock Market Game For Kids?

Newspaper is running a story on Stock Market Game for school children. 81,000 students, some as young as fourth-graders, took part in this year's competition. Each team receives simulated portfolios of $100,000 and tries to generate the maximum returns in 10- or 15-week periods.

The adults are really enthusiastic about the kids involves in stock trading. "I know lots of people who could have used your investment advice this year," quipped Brian Riley, managing director for Merrill Lynch in San Francisco. "When Obama came out with his green program, they started looking for solar companies," one teacher said. It sounds as if the kids really have a strategy. Or is it really a poker game?

The winning team, eighth-graders Nestor Aguirre, Anthony Poimboeuf and John D. Giannini turned $100,000 into more than $361,000 in a 15-week period that ended April 24. I wish the game would have held in last September. Because it would ensure massive bloodshed among our little traders. And this will prove to be their most valuable life lesson.

2009.05.13 [] - comments

 

Two investment books

I have just completed two investment books - "The Intelligent Asset Allocator" by William Bernstein and "The Only Guide to Alternative Investments You'll Ever Need" by Larry Swedroe and Jared Kizer. Both books argue for asset allocation as the best investment strategy. I am not planning to write any detail review this time. I have been reading about asset allocation for many years, and am quite convinced it is the best strategy for me. The interesting things I have learned from the books is many supposing smart investment devices have failed miserably, often involve big risk but have a return that trail market index.

So I'm just going to settle with a allocation plan, ignore all the market noises and patiently let the investment work.

2009.03.30 [, ] - comments

 

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