WATCH: "Fear the Boom and Bust" rap!

a very professional rap created to explain the economic debate that has been raging in politics and economics for 80 years. Fun and well done -who doesn't love an economic theory rap?

http://www.youtube.com/watch?v=d0nERTFo-Sk

There is a great book: The Commanding Heights and PBS series, based on the book, that discusses how this debate has effected all of our lives since the great depression. I highly recommend it.

Your Money & Your Brain - Risk

In Chapter 6 of Jason Zweig's Your Money & Your Brain, Jason explains that we don't have a defined "risk tolerance." He emphasizes several areas that effect our risk tolerance: mood, framing, how we react to percentages and herd menatality.

Studies show that the amount of risk you can take is directly correlated to your mood.

From a survival standpoint, says psychologist Amos Tversky, risk was a matter of life and death. Sensitivity to losses was more beneficial than the appreciation of gains. Over thousands of generations, a "better safe than sorry" reflex has become ingrained in humans. Various studies show, that depending on our mood, we react differently to risky situations.

Secondly, we also react to how things are framed. Researchers have demonstrated this in many ways. One classic study showed that when a four ounce glass of water has two ounces poured out , 69% of people will say the glass is half empty. If the same glass starts out empty and has two ounces poured in, 88% of people will say the glass is half full. This is a perfect example of how equivalent ways of describing something should lead to equivalent decisions. But that is not what happens.

Zweig gives many examples on where framing exists in the financial world. For example, if you put 1% of your money in a single stock that goes to zero you would be very upset. But if you lost 1% of your total portfolio you would not be as upset. You would shrug it off as a routine fluctuation.

The third factor effecting risk is how we react to percentages vs. how we react to odds expresed as frequencies. That is because percentages are abstract to people. People who are told that a surgery has a 10% failure rate react less severely to a 1 in 10 failure rate. that is because we visualize that 1 person.

Finally, Zweig explains that most of us are subject to peer pressure. People in the same office tend to invest their 401Ks in a similar manner. Even, the "smart money," supposedly independent minded investors like hedge funds, insurance companies, foundations and pension funds tend to invest in the same manner.

As in previous chapters, Zweig offers some advice to help investors manage their brain:

* Always take a time out and wait a day. remember a fight with your spouse or a good round of golf may be influencing your decision.

* Look back at history. No market continually rises. There are boom and bust cylces. When the bust comes, can you handle it?

* Reframe: if someone says the odds of success are 80%, then ask yourself if you are comfortable with a 2 out of 10 chance of loss.

* Since no one has a defined risk tolerance, think in terms of how an investment decision effects your goals, objectives, and outcomes. Have a personal investment policy statement (IPS) and stick to it.

Jason Zweig's column in WSJ

Jason always has sound advise. I recommend reading todays column:

http://online.wsj.com/article/SB20001424052702304871704575160190948059722.html#mod=todays_us_money_and_investing

Great Book on Auto Industry

I have been listening to Crash Course by Paul Ingrassia, writer for the Wall Street Journal. If you are at all interested in the US auto industry this is a must read: http://www.amazon.com/Crash-Course-American-Automobile-Industrys/dp/1400068630/ref=sr_1_1?ie=UTF8&s=books&qid=1270204897&sr=8-1

I also recommend: The End of Detroit: How the Big Three Lost Their Grip on the American Car Market by Micheline Maynard. I read this several years ago and the lesson I took from the book is that Americans can compete in the auto industry if they are allowed to operate in a good system. It is Americans that are engineering and building the high quality Honda's, Toyotas, and Nissans sold in America today.

Your Money & Your Brain - Confidence

What I love about this book is that its findings and applications apply to many areas in life. At a later date, I will post a blog on how these same principles apply to social policy and human motivation.

In Chapter five, Zweig discusses the dangers of inherit in confidence. We as humans have a tendency to believe that we are better looking, smarter, funnier etc. than we really are. Studies show that we rate ourselves consistently above average on any item measured. How can that be? by definition we all cant be above average. This is not a bad thing, if we didn't have confidence we we would never take risks.

Unfortunately, in investing, this overconfidence can lead to underperformance:

* We believe we are smarter than the collective market. Surveyed investors believe they will outperform the market by 1.5 percentage points. Mutual fund investors believe the funds they pick will outperform the market. Again, how can we all beat the market?

* We put too much faith in what is familiar. This "home bias" leads to too little allocated to foreign investments and too much invested in our own companies stock (think Enron). Brain scans of investors show that when considering placing money in foreign markets their amygdala (brains fear center) kicks in. Staying close to home feels safer.

* We think we have more control than we do.

* We have "hindsight' bias. We think we predicted what occurred, which leads us to think we can predict the future.

* We hate to admit that we don't know something. Ironically, this means we are overconfident in our abilities to overcome our overconfidence.

A great point in the chapter is Zweigs discussion of "illusion of control". More than any other activity except sports and gambling this effect exists in investing. Illusion of control exists when:

* activity appears partly random

* there are choices

* involves competition

* can be practiced

* requires effort

* feels familiar

This results in what Zweig calls the Colonel Klink illusion. You think you are in control. But you are not.

What can we do to protect ourselves:

1. You need to say "i dont know" then learn more.

2. Discount your expectations by 25% before you act.

3. Write down why you made the decision you did. Write out "i think this investment will go up because_______________."

4. Learn what works by tracking what doesn't

5. Don' t just buy what you know and don't get stuck on your co.'s stock.

6. Diversification is the best defense.

This last point is huge. I have studied investing for the last 25 years, I am convinced that there is no better investing strategy other than building a well diversified portfolio that is appropriate for your capacity for risk and doing little, other than re-balancing it annually, or adjusting for changes in life circumstance.

Social Security Information

The following link is a very good tool for anyone approaching retirement age and trying to decide when to start social security benefits:

http://www.fpajournal.org/CurrentIssue/TableofContents/SocialSecurityWhentoStartBenefits/

Nice overview of Efficient Market Theory

This brief article is a nice summary of the Efficient Market Theory (EMT). Read this and you will gain a good understanding on the debate that is currently going on in the investing world.

The EMT is the theoretical underpinnings that support indexing and diversification.

http://researchmag.com/Issues/2010/April-1-2010/Pages/Efficiently-Controversial.aspx