New Blog material

I have started to re-read Common Sense on Mutual Funds the updated 10th anniversary edition, by John Bogle. Bogle is the founder of Vangaurd and one of the most respected persons in the investing field. If there is one book I would recommend on investing this would be it. I will be blogging on important insights as I read.

3 Important Books

This past winter I have read and been influenced by 3 books that discuss what we know about the human mind and its effects on our daily lives:

Your Money & Your Brain by Jason Zweig - I have blogged on this extensively. Zweig relates what we know about the brain and how it effects us as decision makers.

Drive - The Surprising Truth About What Motivates Us by Daniel Pink. Pink explores the psychology of human motivation. He argues that todays work environment requires us to move away from traditional carrot and stick approach to management and into what he calls motivation 3.0. Motivation 3.0 emphasizes understanding the intrinsic human need for belonging, learning and creating. If you manage people this is a must read.

NUDGE: Improving Decisions About Health, Wealth and Happiness by Richard Thayer and Cass Sustein. In this book, the University of Chicago professors argue for governments nudging people into better decisions. They refer to their approach as "libertarian paternalism" They explain that we are sometimes guided by our brains into poor decisions. Since we understand this, should we not design systems that help us make better decisions related to wellness, 401k savings, energy conservation etc. ?

Your Money & Your Brain - Final Advice

Zweig ends YM&YB with the following:

T ake a global view

H ope for the best, expect the worst. Learn market history to help avoid panicking in bad times.

I Investigate, then invest.

N ever say always. No matter how sure you are of an investment, don't invest more than 10%.

K now what you don't know. Find out if people pushing it are putting their money in it.

T he past is not a prologue. Don't buy an investment just because it has been going up.

W eigh what they say. Ask a forecaster for a complete history of all their predictions.

I f it sounds too good to be true it probably is.

C osts matter. if you aren't careful expenses and taxes can easily eat up 1/2 of your return.

E ggs go splat. Don't put all your eggs in one basket.

Sounds very simple. But if the people who invested with Bernie Madoff followed this advice, many would be BILLIONS richer today.

Your Money & Your Brain - Happiness

Studies show that having wealth does not make people happy. once you have enough to meet your basic needs, more money creates less happiness than one would think.

The human tendency to be envious can rule our lives. When we buy the smallest house in a nice neighborhood we will be less happy than having the biggest house in a neighborhood of smaller houses. This envy reflex helps us to work to survive and gives us hope for the future. But unless we control this urge we will chronically be unsatisfied. There will always be someone with more. This explains why people in rich countries are only as happy as those in some poorer countries. We are constantly comparing ourselves to the "Jones"

What is the secret to happiness:

Zweig explains that your memory looks for favorably on past events as time passes. This leads to a phenomenon where past experiences grow in value as your memory of it grows warmer. Contrast this with the acquisition of items (new car, kitchen, etc.) which depreciate in value to the owner over time. Experiences trump acquisitions.

He also states that the happiest people are those that spend less time alone and had more friends.

We need to enjoy our friends, family and experiences in order to have a happy fulfilled life. This sounds like classic cliche, but it is backed by scientific research.

4 Podcasts that explain the credit crisis

Over the last couple years I have come across 4 podcasts that do a wonderful job of explaining the credit/mortgage crisis that shook our economy:

EconTalk 5/17/2010 Russ Roberts, Professor of Economics at George Mason University and host of the podcast EconTalk, does a wonderful job of presenting an overview of a paper he has written on the topic. It is a open and fair explanation of the events and circumstances that may have resulted in the crisis. Roberts focuses attention on various incentives that may have been in play.

EconTalk 9/29/08 interview with Arnold Kling - Kling was formerly employed at Freddie Mac and starts by explaining how a mortgage works all the way through the real estate bubble and its consequences. Listen to this first as a good basis.

This American Life: "Giant Pool of Money" and "Inside Job" - you may have to pay .99 to get these. They are well worth it.

Also: listen to NPR's Planet Money podcasts.

I make EconTalk and Planet Money podcasts mandatory listening every week. They are always enlightening.

Your Money & Your Brain - Surprise (READ THIS)

Jason Zweig writes the following in chapter 8: "After writing about Wall Street since 1987 and studying centuries worth of financial history, I have become convinced that the prevailing view of what the future holds is almost always wrong. In fact, the only incontrovertible evidence that the past offers about the financial markets is that they will surprise us in the future. The corollary to this historical law is that the future will most brutally surprise those who are the most certain they understand it. Sooner or later, sometimes slowly and sometimes suddenly - but with a diabolical ability to root out everyone who has ever gazed into a crystal ball - the financial markets will humiliate whoever thinks he knows whats coming"

Zweig wrote the above in 2007.

I like this because it flies in the face of all the CNBC and financial prognosticators who are so confident they know the next turn of the market or hot stock or hot sector.

In this chapter on surprise Zweig explains that it is our anterior cingulate cortex (ACC) that tunes the rest of our brain to danger. Its part of our intuitive system that helps us respond quickly to danger. In the biological world that we live in, it is more important to respond quickly to dangers versus successes.

This helps account for our panic when markets start to fall.

Zweig reminds us to:

* Remember that "everyone knows nothing" - what everybody knows is already embedded in the price, so what everybody knows does not give you an edge. Unless you have some great insight, you don't know anything that the market has already built into the price.

and that,

*High hopes cause trouble. Growth stocks that miss earnings by just a small amount can spell big losses. Conversely, value stocks tend to have low hopes and so when positive news on a value stock becomes public they tend to have large increases. Classic examples of our brain reacting to surprises.

Your Money & Your Brain - Fear

Chapter 7 of YM & YB discusses fear. The manner in which our brains process fear has a large effect on how we invest.

The more vivid and imaginable a risk is the scarier it feels, and the ensuing fear is effected by what psychologists call "dread" and "knowability."

Dread is determined by how vivid or catastrophic an event seems to be.

Knowability is how immediate or specific the consequences appear to be. Plane crashes seem more "knowable" than health dangers brought on by pesticides.

When we feel we understand the situation and are in control we underestimate the risks. We tend to be more fearful of flying than driving after having a couple of drinks. Yet, the driving is much riskier.

We have a greater fear of losing all our money in a market crash versus losing our nest egg to inflation. The dread and unknowabilty dominate our thinking.

Your brains amygdala, which is part of your reflexive brains alarm system, further contributes to potentially bad investment decisions. This part of your brain responds to all kinds of signals and even words. So when you watch a news story of a bad day on the trading floor, you see traders arms gesturing wildly, clanging bells, and you hear alarming words: crash, panic, etc.

Studies show that when you see this, your armygdala is very active and is filling you with fear signals.

Zweig recommends several tactics that you can use to keep your fears in check:

1. When you feel overwhelmed with fear. take a time out. Let your circuits settle.

2. Ask yourself:

* other than price, what else has changed?

* are my original reasons to invest still valid?

* If i liked this investment at a higher price, do I like it now that it is cheaper?

3. Resist the pull of the herd. Ask someone who may not have an interest in your investment whether the fear is reasonable and if you were in my shoes what other information would you require before making a decision.