Investing to Avoid the Consequences of Being Wrong

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Jeff Albertson
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Investing to Avoid the Consequences of Being Wrong

Post by Jeff Albertson »

AAII interviewed Bill Bernstein recently & published it under the title 'Investing to Avoid the Consequences of Being Wrong'.
William “Bill” Bernstein is a neurologist, co-founder of the investment firm Efficient Frontier Advisors and the author of several books. We spoke at the Morningstar Investor Conference about his approach to investing, which includes avoiding the risk of running out money.

—Charles Rotblut, CFA
http://www.aaii.com/journal/article/inv ... ong.mobile
Levett
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Levett »

That's a good interview. Thanks for posting the link.

Lev
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Re: Investing to Avoid the Consequences of Being Wrong

Post by boglephreak »

good read, thanks
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Fallible »

A very good interview and thanks for posting.

Much, of course, is not new for Bogleheads who have read his books, in particular his emphasis on knowing investing history. But I was surprised when he said that "the neuroeconomic angle of investing has been grossly overplayed. It is all common sense. Ben Graham said it as well as it needed to be said...'The biggest enemy that you've got is the face starting back at you in the mirror.'"

Common sense and face in the mirror I think we all agree on. But he wasn't asked why he thinks the neuroeconomic angle is "grossly overplayed" (not just overplayed, but grossly so), yet with his training in neurosciences, it would be especially interesting to know more of his thoughts on that. He will be at the Bogleheads' annual conference in Philly next week, so perhaps someone there could ask him?
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Re: Investing to Avoid the Consequences of Being Wrong

Post by VictoriaF »

Curiously, in the beginning Bill says:
Bill Bernstein wrote:WB: Yes. I am trained in neurosciences and I think that the neuroeconomic angle of investing has been grossly overplayed.
But then much of his guidance addresses cognitive weaknesses and biases that lead an investor astray.

Victoria
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Fallible »

Deleted.
Last edited by Fallible on Sat Sep 24, 2016 12:38 pm, edited 1 time in total.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by arcticpineapplecorp. »

Great article. Thanks for sharing. My favorite parts:
We all evolved from people who evolved over 5,000 or 10,000 years from settled farmers. Very few of us evolved directly from Genghis Khan. We evolved from people who ran farms. The time horizon then was crop cycles, which is about a year. That’s what the planning horizon was. In fact, when you do neurobehavioral studies on peoples’ risk tolerance, they seem to behave as if their risk tolerance is about one year. This is what Shlomo Benartzi and Richard Thaler found.

Guess what? You’ve now got a time horizon of 50 years. So we are completely maladapted.
and
The trick is to find that stock/bond allocation where you feel at those points about half the time each. Let’s say your allocation is 60% stocks/40% bonds. If half the time you feel bad that you don’t have enough in stocks and half the time you feel bad that you don’t have enough in bonds, then you know that’s the right allocation. If at 60% you feel bad that you have too much stocks all the time, then you have too much in stocks. Bonds allow you to sleep at night.

For most people, over the long term it probably is optimal to be 100% in stocks, but almost nobody can execute that optimal strategy. So, a suboptimal strategy that you can execute is better than an optimal one you can’t. For most people, the best path is one that involves owning a large amount of bonds so they can sleep at night during the bad times.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by roflwaffle »

I liked it for the most part, but this paragraph bugged me.
At the opposite end of the spectrum you have an old person who has little savings. For that person, you combine any kind of a reasonable burn rate, 5% or 6%, with a bad series of stock returns like we saw back in the 1960s and 1970s—real (inflation-adjusted) stock returns that is—or that we saw of course during the Great Depression. Within five or 10 years, they are going to be toast. I use this as a metaphor, but they may be pushing a shopping cart under a bridge if they are really unlucky. That is the outcome you want to avoid. The moral is that for the older person who is retired and living off their savings, stocks are extremely risky.
It glosses over the biggest issue in my opinion, which is that any portfolio where net withdraws are greater than net earnings will eventually drop to nil.

Besides that, comparing equities to bonds, at least during the 70s (1972+), is a red herring according to PV. Both 100% equities and 100% bonds drop to nothing by 1994 with a fixed yearly withdrawal (5% of the starting balance). 50/50 equities on the other hand manage to eek out an extra 3 years, which is why someone should stick with a balanced portfolio if they're going to use more than their portfolio earns.

Along the same lines, I'm not sure what kind of portfolio would drop to nothing in 5 years with a 5% withdraw rate...
:oops:
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Levett »

For me, his recollection of Buffett's comment is the absolute "winnah":

"There is a wonderful expression that Warren Buffett used to describe the principals of Long-Term Capital Management, the large hedge fund that blew up in the 1990s and required a bailout from the Federal Reserve. I believe the quote is that, “To make the money they didn’t have and they didn’t need, they risked what they did have and did need.”

There are some people for whom enough is simply not enough.

Lev
Last edited by Levett on Sat Sep 24, 2016 2:30 pm, edited 1 time in total.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Dandy »

Dr. Bill's philosophy for retirees who have "enough" to have 20-25 years of residual expenses in "safe" assets and invest the rest anyway you want was a game changer for me. Not only does it invest to avoid the consequences of being wrong - it is a sleep well investment approach.

No investment plan is perfect and you need to check on your health, portfolio and expenses and make adjustments when necessary. But the above bottom up approach i.e. what do I need to safe guard my retirement, seems to make more sense for some retirees than guessing that 60/40 or 50/50 allocations are conservative enough or aggressive enough or relying on retirement software that projects your degree of success by using historical performance.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by littlebird »

arcticpineapplecorp. wrote:
The trick is to find that stock/bond allocation where you feel at those points about half the time each. Let’s say your allocation is 60% stocks/40% bonds. If half the time you feel bad that you don’t have enough in stocks and half the time you feel bad that you don’t have enough in bonds, then you know that’s the right allocation.
:confused


So we're supposed to feel bad all the time? Well I must be doing something wrong, because I feel very good about my finances and specifically my AA all the time.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Fallible »

VictoriaF wrote:Curiously, in the beginning Bill says:
Bill Bernstein wrote:WB: Yes. I am trained in neurosciences and I think that the neuroeconomic angle of investing has been grossly overplayed.
But then much of his guidance addresses cognitive weaknesses and biases that lead an investor astray.

Victoria
Right, so as I posted earlier, it would be interesting to know what he means by the neuroeconomic "angle" and what about it is being grossly overplayed. I'm not suggesting it's not being overplayed because I 'm not qualified to know that. It's just that I've read so much about neuroscience and investing and am always interested in all the angles.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by dougger5 »

littlebird wrote:
arcticpineapplecorp. wrote:
The trick is to find that stock/bond allocation where you feel at those points about half the time each. Let’s say your allocation is 60% stocks/40% bonds. If half the time you feel bad that you don’t have enough in stocks and half the time you feel bad that you don’t have enough in bonds, then you know that’s the right allocation.
:confused


So we're supposed to feel bad all the time? Well I must be doing something wrong, because I feel very good about my finances and specifically my AA all the time.
I also find that to be a tricky barometer. To be effective, I think it requires reflection over one's feelings in past situations, as the anxiety of not holding enough in either category tends to peak at different times. I.E., in bull markets you have equity envy, while in bear markets you might wish you had more in bonds.

But if you really do feel good all the time, then it's not inconsistent with the point, as it's still the same level of anxiety...it just happens to be zero :D
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Buddtholomew »

Reminds me of something my late grandfather told me...
It's only a good deal when both parties are unhappy.
The seller thinks he got too little and the buyer thinks he paid too much.

I see this as analogous to the Bernstein comment that you're at the correct AA for you when you feel torn between having too much/little in equity and too little/much in bonds. "Cognitive Dissonance."
"The first principle is that you must not fool yourself and you are the easiest person to fool" --Feynman.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by VictoriaF »

Fallible wrote:
VictoriaF wrote:Curiously, in the beginning Bill says:
Bill Bernstein wrote:WB: Yes. I am trained in neurosciences and I think that the neuroeconomic angle of investing has been grossly overplayed.
But then much of his guidance addresses cognitive weaknesses and biases that lead an investor astray.

Victoria
Right, so as I posted earlier, it would be interesting to know what he means by the neuroeconomic "angle" and what about it is being grossly overplayed. I'm not suggesting it's not being overplayed because I 'm not qualified to know that. It's just that I've read so much about neuroscience and investing and am always interested in all the angles.
Neuroeconomics is essentially Behavioral Economics where experiments are conducted with fMRI and other neuroscience equipment. As subjects are responding to experimental and control questions, the researchers are watching which brain regions become active,

Visually, these experiments are very impressive, but I prefer Kahneman's and Tversky's questionnaires. It would be difficult to recreate Linda under fMRI.

Victoria
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Re: Investing to Avoid the Consequences of Being Wrong

Post by nedsaid »

VictoriaF wrote:
Neuroeconomics is essentially Behavioral Economics where experiments are conducted with fMRI and other neuroscience equipment. As subjects are responding to experimental and control questions, the researchers are watching which brain regions become active,

Visually, these experiments are very impressive, but I prefer Kahneman's and Tversky's questionnaires. It would be difficult to recreate Linda under fMRI.

Victoria
I don't think investors have to get this fancy. Understanding the greed/fear dynamic goes a long way. Pretty much people like what has recently performed well and what is popular. In bad markets, people tend to panic and sell investments at the wrong time. Not sure I buy into the evolutionary stuff, but Bernstein's essential point that our time horizons are too short is spot on.

It is knowing about human nature and human behavior that is helpful, knowing what sections of the brain light up under certain circumstances seems more iffy to me. This whole field of brain science is relatively new and we are discovering things all the time. Also, cutting edge research is sometimes proved wrong with time.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by malabargold »

"For most people, over the long term it probably is optimal to be 100% in stocks, but almost nobody can execute that optimal strategy."

The only take home point for me:
Don't hold bonds.

High risk tolerance has served me well over the decades.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by VictoriaF »

nedsaid wrote:
VictoriaF wrote:
Neuroeconomics is essentially Behavioral Economics where experiments are conducted with fMRI and other neuroscience equipment. As subjects are responding to experimental and control questions, the researchers are watching which brain regions become active,

Visually, these experiments are very impressive, but I prefer Kahneman's and Tversky's questionnaires. It would be difficult to recreate Linda under fMRI.

Victoria
I don't think investors have to get this fancy. Understanding the greed/fear dynamic goes a long way. Pretty much people like what has recently performed well and what is popular. In bad markets, people tend to panic and sell investments at the wrong time. Not sure I buy into the evolutionary stuff, but Bernstein's essential point that our time horizons are too short is spot on.

It is knowing about human nature and human behavior that is helpful, knowing what sections of the brain light up under certain circumstances seems more iffy to me. This whole field of brain science is relatively new and we are discovering things all the time. Also, cutting edge research is sometimes proved wrong with time.
I too find the psychology-based, Kahneman/Tversky/Ariely type of behavioral economics more interesting than the technology-based neuro-economics. It's fun to play with equipment, but Kahneman's and Tversky's questions were ingenious in their simplicity and insightful in their findings, which would be difficult to replicate in an fMRI machine. Nevertheless, some information can be uncovered only with equipment. For example, fMRI-based experiments showed how the subjects have subconsciously made their decisions (one region of their brain got activated) before they have consciously made the same decisions (a different region turned on).

Are these findings useful for investing? The holy grail of investors' mistakes is that in a rising market they discover that "100% stocks provide the best returns on the long run," and in a falling market they realize that "this time it can be different." Historically and philosophically, "this time it can be different" is more legitimate than "100% stocks provide the best returns on the long run." Every positive trend eventually ends.

As neuroeconomics helps identifying what goes through one's brain when he or she is buying or selling stocks, perhaps it could also suggest alarms and barriers against bad decisions. In the mean time, the best approach is to make a prudent decision and stay away from temptations.

Victoria
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Fallible »

VictoriaF wrote:
nedsaid wrote:
VictoriaF wrote:
Neuroeconomics is essentially Behavioral Economics where experiments are conducted with fMRI and other neuroscience equipment. As subjects are responding to experimental and control questions, the researchers are watching which brain regions become active,

Visually, these experiments are very impressive, but I prefer Kahneman's and Tversky's questionnaires. It would be difficult to recreate Linda under fMRI.

Victoria
I don't think investors have to get this fancy. Understanding the greed/fear dynamic goes a long way. Pretty much people like what has recently performed well and what is popular. In bad markets, people tend to panic and sell investments at the wrong time. Not sure I buy into the evolutionary stuff, but Bernstein's essential point that our time horizons are too short is spot on.

It is knowing about human nature and human behavior that is helpful, knowing what sections of the brain light up under certain circumstances seems more iffy to me. This whole field of brain science is relatively new and we are discovering things all the time. Also, cutting edge research is sometimes proved wrong with time.
I too find the psychology-based, Kahneman/Tversky/Ariely type of behavioral economics more interesting than the technology-based neuro-economics. It's fun to play with equipment, but Kahneman's and Tversky's questions were ingenious in their simplicity and insightful in their findings, which would be difficult to replicate in an fMRI machine. Nevertheless, some information can be uncovered only with equipment. For example, fMRI-based experiments showed how the subjects have subconsciously made their decisions (one region of their brain got activated) before they have consciously made the same decisions (a different region turned on).

Are these findings useful for investing? The holy grail of investors' mistakes is that in a rising market they discover that "100% stocks provide the best returns on the long run," and in a falling market they realize that "this time it can be different." Historically and philosophically, "this time it can be different" is more legitimate than "100% stocks provide the best returns on the long run." Every positive trend eventually ends.

As neuroeconomics helps identifying what goes through one's brain when he or she is buying or selling stocks, perhaps it could also suggest alarms and barriers against bad decisions. In the mean time, the best approach is to make a prudent decision and stay away from temptations.
Victoria
This last graf is, simply put, what it's all about - knowing ourselves, our emotions, which can help us determine our emotional tolerance for risk, better understand the decisions we make, and hopefully lead to wise investing. Behavioral Econ and neoroeconomics both provide answers - and raise more questions. That is why, to return to my original posts, I wondered what Bill Bernstein meant by neuroeconomic angles being "grossly overplayed."
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
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Re: Investing to Avoid the Consequences of Being Wrong

Post by VictoriaF »

Fallible wrote:This last graf is, simply put, what it's all about - knowing ourselves, our emotions, which can help us determine our emotional tolerance for risk, better understand the decisions we make, and hopefully lead to wise investing. Behavioral Econ and neoroeconomics both provide answers - and raise more questions. That is why, to return to my original posts, I wondered what Bill Bernstein meant by neuroeconomic angles being "grossly overplayed."
I was wondering about the same thing. There are two interpretations:
1. Bill accepts Behavioral Economics findings but thinks that Neuro-Economics is still not mature enough to be useful for everyday investing strategies.
2. Bill referred to Neuro-Economics synonymously with Behavioral Economics.

If the former, I agree with him. If the latter, Bill's references to behavioral mistakes throughout the interview, including references to Danny Kahneman, show that BE is quite potent.

Victoria
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Fallible »

VictoriaF wrote:
Fallible wrote:This last graf is, simply put, what it's all about - knowing ourselves, our emotions, which can help us determine our emotional tolerance for risk, better understand the decisions we make, and hopefully lead to wise investing. Behavioral Econ and neoroeconomics both provide answers - and raise more questions. That is why, to return to my original posts, I wondered what Bill Bernstein meant by neuroeconomic angles being "grossly overplayed."
I was wondering about the same thing. There are two interpretations:
1. Bill accepts Behavioral Economics findings but thinks that Neuro-Economics is still not mature enough to be useful for everyday investing strategies.
2. Bill referred to Neuro-Economics synonymously with Behavioral Economics.

If the former, I agree with him. If the latter, Bill's references to behavioral mistakes throughout the interview, including references to Danny Kahneman, show that BE is quite potent.
Victoria
The first interpretation seems more plausible, but how would it lead to overplaying and overplaying what? Another possibility is that the colorful brain scans that wow some people, even when they're not certain what they mean, are being overplayed, or not being related to investing. I don't know, but I do wish the interviewer had asked Bill what he meant.

Agree with you on the potency of BE as expressed by Bill.
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
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Re: Investing to Avoid the Consequences of Being Wrong

Post by qwertyjazz »

VictoriaF wrote:
Fallible wrote:This last graf is, simply put, what it's all about - knowing ourselves, our emotions, which can help us determine our emotional tolerance for risk, better understand the decisions we make, and hopefully lead to wise investing. Behavioral Econ and neoroeconomics both provide answers - and raise more questions. That is why, to return to my original posts, I wondered what Bill Bernstein meant by neuroeconomic angles being "grossly overplayed."
I was wondering about the same thing. There are two interpretations:
1. Bill accepts Behavioral Economics findings but thinks that Neuro-Economics is still not mature enough to be useful for everyday investing strategies.
2. Bill referred to Neuro-Economics synonymously with Behavioral Economics.

If the former, I agree with him. If the latter, Bill's references to behavioral mistakes throughout the interview, including references to Danny Kahneman, show that BE is quite potent.

Victoria
Possibility 3 is he is referring to mutual funds that try to use the science to watch trends and try to make extra alpha
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Re: Investing to Avoid the Consequences of Being Wrong

Post by VictoriaF »

qwertyjazz wrote:
VictoriaF wrote:
Fallible wrote:This last graf is, simply put, what it's all about - knowing ourselves, our emotions, which can help us determine our emotional tolerance for risk, better understand the decisions we make, and hopefully lead to wise investing. Behavioral Econ and neoroeconomics both provide answers - and raise more questions. That is why, to return to my original posts, I wondered what Bill Bernstein meant by neuroeconomic angles being "grossly overplayed."
I was wondering about the same thing. There are two interpretations:
1. Bill accepts Behavioral Economics findings but thinks that Neuro-Economics is still not mature enough to be useful for everyday investing strategies.
2. Bill referred to Neuro-Economics synonymously with Behavioral Economics.

If the former, I agree with him. If the latter, Bill's references to behavioral mistakes throughout the interview, including references to Danny Kahneman, show that BE is quite potent.

Victoria
Possibility 3 is he is referring to mutual funds that try to use the science to watch trends and try to make extra alpha
Good point. While cognitive biases are real, funds that are trying to turn biases into alphas are gimmicks.

Victoria
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Fallible »

VictoriaF wrote:
qwertyjazz wrote:
VictoriaF wrote:
Fallible wrote:This last graf is, simply put, what it's all about - knowing ourselves, our emotions, which can help us determine our emotional tolerance for risk, better understand the decisions we make, and hopefully lead to wise investing. Behavioral Econ and neoroeconomics both provide answers - and raise more questions. That is why, to return to my original posts, I wondered what Bill Bernstein meant by neuroeconomic angles being "grossly overplayed."
I was wondering about the same thing. There are two interpretations:
1. Bill accepts Behavioral Economics findings but thinks that Neuro-Economics is still not mature enough to be useful for everyday investing strategies.
2. Bill referred to Neuro-Economics synonymously with Behavioral Economics.

If the former, I agree with him. If the latter, Bill's references to behavioral mistakes throughout the interview, including references to Danny Kahneman, show that BE is quite potent.

Victoria
Possibility 3 is he is referring to mutual funds that try to use the science to watch trends and try to make extra alpha


Good point. While cognitive biases are real, funds that are trying to turn biases into alphas are gimmicks.

Victoria
Yes, and such gimmickry could be described as "grossly overplayed." But how would they do this? Probably similar to the way they (and the ad agencies) have used and often misused behavioral finance.
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
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Re: Investing to Avoid the Consequences of Being Wrong

Post by pkcrafter »

Victoria/Fallible, ask Bill to expand on this a bit. :happy

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Re: Investing to Avoid the Consequences of Being Wrong

Post by David Jay »

My takeaway quote: "a sub-optimal strategy that you can execute is better than an optimal one you can’t"
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Fallible »

pkcrafter wrote:Victoria/Fallible, ask Bill to expand on this a bit. :happy

Paul
Good idea, though I had thought he might see the thread and reply, which he sometimes does.
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Re: Investing to Avoid the Consequences of Being Wrong

Post by Watty »

arcticpineapplecorp. wrote:Great article. Thanks for sharing. My favorite parts:
We all evolved from people who evolved over 5,000 or 10,000 years from settled farmers. Very few of us evolved directly from Genghis Khan. We evolved from people who ran farms. The time horizon then was crop cycles, which is about a year. That’s what the planning horizon was. In fact, when you do neurobehavioral studies on peoples’ risk tolerance, they seem to behave as if their risk tolerance is about one year. This is what Shlomo Benartzi and Richard Thaler found.

Guess what? You’ve now got a time horizon of 50 years. So we are completely maladapted.
Oddly enough genetic studies have found that about 1 in 200 people in the world could be descended from Genghis Khan. (or at least his clan)
Genghis Khan, the fearsome Mongolian warrior of the 13th century, may have done more than rule the largest empire in the world; according to a recently published genetic study, he may have helped populate it too.

An international group of geneticists studying Y-chromosome data have found that nearly 8 percent of the men living in the region of the former Mongol empire carry y-chromosomes that are nearly identical. That translates to 0.5 percent of the male population in the world, or roughly 16 million descendants living today.
http://news.nationalgeographic.com/news ... nghis.html
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