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Some Behavioral Finance Publications to Review

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Selected Classic Readings of Interest

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 I worked with a Certified Medical Planner™ on several occasions in the past, and will do so again in the future. This book codified the vast body of knowledge that helped in all facets of my financial life and professional medical practice.

Dr. James E. Williams DABPS [Foot and Ankle Surgeon, Conyers, Georgia]

There is a constantly changing field for rules, regulations, taxes, insurance, compliance, and investments. This book assists readers, and their financial advisors, in keeping up with what’s going on in the healthcare field that all doctors need to know.

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Rationality and Emotions in Financial Decisions [Video]

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Rationality and Emotions in Financial Decisions

By Professor Eyal Winter [SFI Seminars]

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

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***

DOES THE STOCK MARKET OVER-REACT?

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Some say it does!

ArtBy Arthur Chalekian GEPC

[Financial Consultant]

Some experts say it does. In 1985, Werner DeBondt, currently a professor of finance at DePaul University, and Richard Thaler, currently a professor of behavioral science and economics at the University of Chicago, published an article titled, Does The Stock Market Overreact? 

Professor Speak

The professors were among the first economists to study behavioral finance, which explores the ways in which psychology explains investors’ behavior. Classic economic theory assumes all people make rational decisions all the time and always act in ways that optimize their benefits. Behavioral finance recognizes people don’t always act in rational ways, and it tries to explain how irrational behavior affects markets.

Research 

DeBondt and Thaler’s research, which has been explored and disputed over the years, supported the idea that markets tend to overreact to “unexpected and dramatic news and events.” The pair found people tend to give too much weight to new information. As a result, stock markets often are buffeted by bouts of optimism and bouts of pessimism, which push stock prices higher or lower than they deserve to be.

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ambulance

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In a recent memo, Oaktree Capital’s Howard Marks reiterated his long-held opinion, “…In order to be successful, an investor has to understand not just finance, accounting, and economics, but also psychology.” He makes a good point.

Assessment 

When markets become volatile, it’s a good idea to remember the words of Benjamin Graham, author of The Intelligent Investor, who wrote, “By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.”

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

***

Our Brain, Computer Operating Systems and Financial Decision Making

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Our default brain operating system is programmed to make poor financial decisions?

Rick Kahler MS CFPBy Rick Kahler MS CFP® http://www.KahlerFinancial.com

If you’ve ever struggled to learn new software or unravel a computer problem, you know that part of the frustration of dealing with technology is its logic. Computers respond according to their default operating systems. If we want them to do something different, they need to be reprogrammed.

In the same way, the default operating systems of our brains are actually programmed to make poor financial decisions. This is normal. Making good financial decisions actually takes a deliberate reprogramming of your internal operating system. Here is why.

Our brains are divided into three sections: the reptilian brain, the mammalian brain, and the prefrontal cortex.

The reptilian brain is the oldest, most primitive part. In a talk at the Financial Therapy Association’s annual conference in July 2015 in San Jose del Cabo, Mexico, Dr. Ted Klontz explained that the reptilian brain continually scans for threats. It is waiting for death to come walking through the doorway, so it lives in anxiety. Since anything positive is not a threat, it’s oblivious to the positive. It also doesn’t understand the concept of the future, but lives only in this moment.

Left to its own programming, then, of course the reptilian brain might have a problem making monthly contributions to a retirement account. Saving for the future isn’t a concept it even understands. Further, it sees taking money out of the checkbook as a threat because that leaves fewer resources to battle death when it comes through the doorway. Making things even worse, the reptilian brain is nearly impossible to change. The best most of us can do is manage it.

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Brain view

***

This brings us to the mammalian brain, whose only job is to manage the anxiety of the reptilian brain. It does so in three ways:

  1. Remove the threat (fight),
  2. Run away from the threat (flight),
  3. Get small and disappear to hide from the threat (freeze).

Most of us favor one of these three responses to threats, and according to Dr. Klontz we select our preferred response by the age of six. When the mammalian brain responds, it processes exponentially faster than the thinking part of our brain, the prefrontal cortex. Because of the ease with which the mammalian brain responds to threats, 90% of all decisions—including financial ones—are made here.

With the mammalian brain managing the anxiety of the reptilian brain, we have a more sophisticated response to our potential retirement plan contribution. Some of us will verbally fight and defeat any messenger (article, employer, financial advisor, spouse) that suggests we drain our current resources to send money into a black hole. Others will simply flee the messenger by diverting our attention to the Monday night football game or any task at hand. A portion of us will just freeze into a glassy-eyed stare. Nobody is home.

That leaves us with our only hope, the understanding and thinking part of the brain, the prefrontal cortex. This part of our brain doesn’t fully come on line until the mid-twenties. It functions as the parent of the other two brains, but unfortunately it processes information very slowly and with great effort.

***

brain

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More:

Assessment

Fortunately, this is the brain that is easiest to change. By training it to become aware when the lower parts of the brain are about to make a hair-trigger decision, we can stop the ensuing action long enough to add logic as well as emotion to the process.

More:

Reprogramming the brain takes time, practice, and using resources like education, mentors, advisors, and counseling. Eventually, wise financial choices like saving for retirement can become the new default programming, even in spite of the reptilian brain.

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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***

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***

Do RetroSpective Thoughts on Apple Inc Hint of the ProSpective Future after the “Crash” Today?

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PART I.

Understanding Apple Requires an Analysis of Fundamentals and Psychology

vitalyBy Vitaliy Katsenelson CFA

So many articles have been written recently about Apple — defending it or explaining why this glorious fruit will turn into a shriveling pumpkin by midnight (with Samsung’s help) — that I really haven’t felt the need to contribute to the unending debate.

But, when Apple’s stock crashed to $450 back in January 2013, we bought a little for our clients. After receiving an outraged e-mail from one of them calling the purchase “irresponsible” and proclaiming that everyone (including his neighbor) knows that Apple is going down to $300, I decided it was time to join the discourse. Clients rarely (almost never) contact us about stocks we own in their accounts. More important, this is far from the most “radioactive” stock we own or have owned.

So, here is a column on Apple, I wrote back then.  I have no intention of defending or prosecuting the company, but I would like to share some thoughts about it that many pundits have either overlooked or ignored.

***

Logo of Apple Inc. to be used on a custom landing page/brand page about Apple products on the website of Shopping.com.

***

The Psychlogy

What makes Apple stock difficult to own is psychology. The company’s success since 2000 is a black swan. We tend to think of Nassim Nicholas Taleb’s black swans as significant random negative events, but Apple is a positive one. When co-founder Steve Jobs came back to the company in the late ’90s, Apple was about to take its last breath. Jobs pulled off a miracle. He revived the company’s computer product line, making Macs exciting again, and then came out with three revolutionary “i” products in a row: the iPod, iPhone and iPad. You could argue that the success of each “i” product in itself was a black swan, exceeding all rational expectations and revolutionizing, transforming and in some cases creating new categories of merchandise that had never existed before.

Revenue and Market Capitalization

Apple’s revenue and market capitalization deservedly surpassed those of almighty Microsoft Corp. — the hairy monster with stinky breath that performed CPR on dying Apple in the late ’90s by injecting liquidity into the company by buying its preferred stock. We have a hard time processing this highly improbable success and an even harder time imagining that there is another black swan about to take flight from the Apple labs, especially with no Steve Jobs around to sit on the egg.

Black swans come out of nowhere, unannounced, but their impact may be long-lasting. The wildly successful “i” gadgets dug a formidable moat around Apple. They created the most valuable and still most inspirational brand in the world, funded an enormous research and development effort, enabled huge buying power (Apple locks up supply and pays much lower prices than many of its competitors for parts), filled out a mature product ecosystem and stuffed Apple’s debt-free balance sheet with $137 billion — half the market capitalization of Microsoft. The moat is wide, deep and unlikely to be breached any time soon.

***

Ex-Cathedra black swan

***

High Price

One reason the psychology of owning Apple stock is so difficult: it’s high price. (Note: I am talking not about its valuation but purely about its price.) Apple has had only one stock split since the late ’90s, when it was trading in double digits, and it now changes hands at about $450 (down from $700 just a few months ago). Stock splits create zero economic value in the long run — absolutely none. Apple could split its stock ten to one and you’d have ten $45 shares, and nothing about the company or its business would change. But, I’d argue that a 3 percent “slide” of $1.35 would grab fewer headlines than a $13.50 “drop” — there is a media magnification factor that is hard to ignore.

Hardware versus Software

Is Apple a hardware or a software company? This is a very important question because Apple’s net margins of 25 percent are dangerously higher than those of Microsoft, a software monopoly that, with the minor exception of the Xbox and its new venture into tablets, sells only software, which has a 100 percent incremental margin.

Apple is either a smart hardware company or a software maker dressed in hardware company clothes. Take a look at the PC businesses of traditional “dumb” hardware companies like Dell and Hewlett-Packard Co. (I am not insulting these companies, I am just highlighting their lack of PC-directed R&D.) They buy hard drives from Western Digital Corp., graphic cards from Nvidia Corp., processors from Intel Corp. and an operating system from Microsoft, then they have contract manufacturers put together these parts in Asia and ship PCs all over the world. Dell and HP engineers design the PCs but contribute minimal R&D to their boxes; most of the R&D is done by the suppliers. Dell and HP are really asset-lite marketing and logistics companies — this explains their razor-thin margins. (Side note: Because of a lack of fixed costs, Dell and HP can remain profitable despite the ongoing decline in PC sales.)

Same Surface

On the surface, Apple’s personal computer business is not that much different from Dell’s or HP’s: It uses the same highly commoditized hardware and it also outsources manufacturing, but Apple spends much more on the R&D of its own operating system and creates distinctive, innovative products. Apple gets to keep a slice of revenue that would otherwise go to Microsoft for the operating system. Also, Apple is able to charge a premium (usually a few hundred dollars per PC) for the aesthetic appeal and perceived ease of use of its products.

However, when it comes to the “i” devices, Apple is a much smarter hardware company; its value added goes further than just basic design and software. Though there is a lot of commoditized hardware that goes into an iPhone or iPad, Apple’s skill at fitting an ever-growing number of components into ever-shrinking devices constantly increases. Add world-class touch and feel, superior battery life and durability, and you have a package that turns what would otherwise be commodity items into highly differentiated, and undeniably sexy, products. Apple has even gone a step further and is designing its own microprocessors.

But — and this is a very important “but” — as phones and tablets mature, processor speed, battery life and weight will tend to become uniform across all devices. It is arguable that the competition has already caught up with Apple in the hardware race. As the hardware premium goes away, there will be only two premiums left: Apple’s brand and its ecosystem. (I will go into detail about the “i” ecosystem and what it means for Apple’s margins and profitability in my second essay posted below).

Note that I did not mention the software premium. Unlike Microsoft, which charges for the Windows operating system installed on PCs, Google gives away Android to anyone who dares to make a phone or a tablet. Unless Apple can maintain the operating system lead against Android, that premium will go away.

Assessment

Recently, I spent a few days playing with Nexus 7, Google’s Android-powered 7-inch tablet, which retails for $200 ($130 cheaper than Apple’s iPad mini). Nexus 7 is a good product, but I kept remembering that humans and monkeys share 98 percent of their DNA, and the Android operating system is missing the 2 percent that makes Apple iOS so special.

*** 

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PART II.

How Much Would You Pay for the Apple Ecosystem?

Apple’s ecosystem is an important and durable competitive advantage; it creates a tangible switching cost (or, an inconvenience) after Apple has locked you into the i-ecosystem. It takes time to build an ecosystem that consists of speakers and accessories that will connect only via Apple systems: Apple TV, which easily recreates an iPhone or iPad screen on a TV set; the music collection on iTunes (competition from Spotify and Google Play lessens this advantage); a multitude of great apps (in all honesty, gaming apps have a half-life of only a few weeks, but productivity apps and my $60 TomTom GPS have a much longer half-life); and, last, the underrated Photo Stream, a feature in iOS 6 that allows you to share photos with your close friends and relatives with incredible ease. My family and friends share pictures from our daily lives (kids growing up, ski trips, get-togethers), but that, of course, only works when we’re all on Apple products. (This is why Facebook bought Instagram for $1 billion. Photo Stream is a real competitive threat to Facebook, especially if you want to share pictures with a limited group of close friends.)

The i-ecosystem makes switching from the iPhone to a competitor’s device an unpleasant undertaking, something you won’t do unless you are really significantly dissatisfied with your i-device (or you are simply very bored). How much extra are you willing to pay for your Apple goodies? Brand is more than just prestige; it is the amalgamation of intangible things like perceptions and tangible things like getting incredible phone and e-mail customer service (I’ve been blown away by how great it is!) or having your problems resolved by a genius at the Apple store.

Of course, as the phone and tablet categories mature, Apple’s hardware premium will deflate and its margins will decline. The only question is, by how much?

Let me try to answer

From 2003 to 2012, Apple’s net margins rose from 1.1 percent to 25 percent. In 2003 they were too low; today they are too high. Let’s look at why the margins went up. Gross margins increased from 27.5 percent to 44 percent: Apple is making 16.5 cents more for every dollar of product sold today than it did in 2001. Looking back at Nokia Corp. in its heyday, in 2003 the Finnish cell phone maker was able to command a 41.5 percent margin, which has gradually drifted down to 28 percent.

Today, Nokia is Microsoft’s bitch, completely dependent on the success of the Windows operating system, which is far from certain. Nokia is a sorry shell of what used to be a great company, while Apple, despite its universal hatred by growth managers, is still, well, Apple. Its gross margins will decline, but they won’t approach those of 2003 or Nokia’s current level.

For Apple to conquer emerging markets and keep what it has already won there, it will need to lower prices. The company is not doing horribly in China — its sales are running at $25 billion a year and were up 67 percent in the past quarter.

However, a significant number of the iPhones sold in China (Apple doesn’t disclose the figure) are not $650 iPhone 5’s but the cheaper 4 and 4s models. (Also, on a recent conference call, Verizon Communications mentioned that half of the iPhones it has sold were the 4 and 4s models.) Apple’s price premium over its Android brethren is not as high as everyone thinks.

What is truly astonishing is that Apple’s spending on R&D and selling, general and administrative (SG&A) expenses has fallen from 7.6 percent and 19.5 percent, respectively, in 2003 to a meager 2.2 percent and 6.4 percent today. R&D and SG&A expenses actually increased almost eightfold, but they didn’t grow nearly as fast as sales. Apple spends $3.4 billion on R&D today, compared with $471 million in 2001. This is operational leverage at its best. As long as Apple can grow sales, and R&D and SG&A increase at the same rate as sales or slower, Apple should keep its 18.5 percentage points gain in net margins through operational leverage.

***

***

Growth of sales is an assumption in itself. Apple’s annual sales are approaching $180 billion, and it is only a question of when they will run into the wall of large numbers. At this point, 20 percent-a-year growth means Apple has to sell as many i-thingies as it sold last year plus an additional $36 billion worth. Of course, this argument could have been made $100 billion ago, and the company did report 18 percent revenue growth for the past quarter, but Apple is in the last few innings of this high-growth game; otherwise its sales will exceed the GDP of some large European countries.

If you treat Apple as a pure hardware company, you’ll miss a very important element of its business model: recurrence of revenues through planned obsolescence. Apple releases a new device and a new operating system version every year. Its operating system only supports the past three or four generations of devices and limits functionality on some older devices. If you own an iPhone 3G, iOS 6 will not run on it, and thus a lot of apps will not work on it, so you will most likely be buying a new iPhone soon. In addition — and not unlike in the PC world — newer software usually requires more powerful hardware; the new software just doesn’t run fast enough on old phones. My son got a hand-me-down iPhone 3G but gave it to his cousin a few days later — it could barely run the new software.

As I wrote above, Apple’s success over the past decade is a black swan, an improbable but significant event, thanks in large part to the genius of Steve Jobs. Today investors are worried because Jobs is not there to create another revolutionary product, and they are right to be concerned. Jobs was more important to Apple’s success than Warren Buffett is to Berkshire Hathaway’s today. (Berkshire doesn’t need to innovate; it is a collection of dozens of autonomous companies run by competent managers.) Apple will be dead without continued innovation.

Jobs was the ultimate benevolent dictator, and he was the definition of a micro-manager. In his book Steve Jobs, Walter Isaacson describes how Jobs picked shades of white for Apple Store bathroom tiles and worked on the design of the iPhone box. He had to sign off on every product Apple made, down to and including the iPhone charger. His employees feared, loved and worshiped him, and they followed him into the fire. Jobs could change the direction of the company on a dime — that was what it took to deliver black i-swans. Jobs is gone, so the probability of another product achieving the success of the iPhone or iPad has declined exponentially.

***

Steve Jobs RIP

***

What is really amazing about Apple is how underwhelming its valuation is today — it doesn’t require new black swans.

In an analysis we tried very hard to kill the company. We tanked its gross margins to a Nokia-like 28 percent and still got $30 of earnings per share (the Street’s estimate for 2013 is $45), which puts its valuation, excluding $145 a share in cash, at 10 times earnings. We killed its sales growth to 2 percent a year for ten years, discounted its cash flows and still got a $500 stock.

There is a lot of value in Apple’s enormous ability to generate cash. The company is sitting on an ever-growing pile of it — $137 billion, about one third of its market cap. Over the past 12 months, despite spending $10 billion on capital expenditures, Apple still generated $46 billion of free cash flows. If it continues to generate free cash flows at a similar rate (I am assuming no growth), by the end of 2015 it will have stockpiled $300 of cash per share. At today’s price [2013] it will be commanding a price-earnings ratio (if you exclude cash) of 4.

Of course, the market is not giving Apple credit for its cash, but I think the market is wrong. Unlike Microsoft, which does something dumber than dumb with its cash every other year, Apple has a pristine capital allocation track record. It has not made any foolish acquisitions — or, indeed, any acquisitions of size. Other than buying an Eastern European country and renaming it i-Country, Apple will not be able to acquire a technologically related company of size, nor will it want or need to. The cash it accumulates will end up in shareholders’ hands, either through dividends or share buybacks.

What is Apple worth?

After the financial acrobatics I’ve done trying to murder the valuation of Apple, it is easier to say that it is worth more than $450 than to pinpoint a price target. When I use a significantly decelerating sales growth rate and normalize margins (reducing them, but not as low as Nokia’s current margins), I get a price of about $600 to $800 a share.

Growth managers don’t want Apple to pay a large dividend, as though that would somehow transform this growing teenager into a mature adult. But I have news for them: Apple already is a mature adult. Second, when your return on capital is pushing infinity (as Apple’s is), you don’t need to retain much cash to grow. Two thirds of Apple’s cash is offshore, but that doesn’t make it worthless; it just makes it worth less — only $65 billion, maybe, not $97 billion, once the company pays its tax bill to Uncle Sam.

***

ImageProxy

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Assessment

In the short term none of the things I am writing about here will matter. Remember, “Everyone knows Apple is going to $300,” as a client recently e-mailed me, as everyone knew it was going to a $1,000 a few months ago when Apple’s stock was trading at $700. The company’s stock will trade on emotion, fundamentals will not matter, and growth managers will likely rotate out of Apple, because once the stock declined from $700 to $450, the label on it changed from “growth” to “value.”

But ultimately, fundamentals will prevail. Like the laws of physics, they can only be suspended for so long. And so, do these retrospective thoughts on Apple hint of future prospects?

More: Should You Buy Apple Stock Ahead of Its September Event

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Vitaliy N. Katsenelson CFA is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley 2007) and The Little Book of Sideways Markets (Wiley, 2010).  His books were translated into eight languages.  Forbes Magazine called him “The new Benjamin Graham”.  

Conclusion

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Investing and the “Tragedy of the Commons”

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On Economics, Investing and Behavioral Finance

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[By Dr. David E. Marcinko MBA]

Although I did not fall asleep during my psychiatry rotations, or psychology classes, in medical school; the concept of ToC was not known to me until my first economics class while in B-School.

What it is!

The tragedy of the commons is a term, originally used by Garrett Hardin, to denote a situation where individuals acting independently and rationally according to each’s self-interest behave contrary to the best interests of the whole group by depleting some common resource.

The term is taken from the title of an article written by Hardin in 1968, which is in turn based upon an essay by a Victorian economist on the effects of unregulated grazing on common land.

Commons” in this sense has come to mean such resources as atmosphere, oceans, rivers, fish stocks, the office refrigerator, energy or any other shared resource which is not formally regulated; not common land in its agricultural sense.

The tragedy of the commons concept is often cited in connection with sustainable development, meshing economic growth and environmental protection, as well as in the debate over global warming. It has also been used in analyzing behavior in the fields of economics, evolutionary psychology, anthropology, game theory, politics, taxation, and sociology.

However the concept, as originally developed, has also received criticism for not taking into account the many other factors operating to enforce or agree on regulation in this scenario.

Example: UMD ‘tragedy of the commons‘ tweet goes viral – Baltimore Sun

Investing Behavior?

Today, some financial advisors, wealth managers, doctors and behavioral psychologists believe the ToC is an increasingly important concept in investing.

Source: https://en.wikipedia.org/wiki/Tragedy_of_the_commons

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confirmation-bias

Greed is still trumping fear, and that’s bad for stocks …

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Assessment

So what does all this have to do with investing? Are we experiencing this phenomenon in the markets, today?

Read the article thru the link above; fear and greed.

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Video on Six Costly Investment Behaviors

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Pathetic results compared to the markets

[Principal of MZ Capital Management]

[Contributor to Morningstar and Physicians Practice]

Most investors are very good at hurting themselves financially. According to latest release of Dalbar’s Quantitative Analysis of Investor Behavior (QAIB), the average investor has a return of only 2.6% over the last ten years. That’s pathetic compared to what the markets gave. See the chart below, over the same period, the S&P 500 gave an annualized return of 7.4% and the bond market gave 4.6%.

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[Click to Enlarge]

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Investor behaviors are such a big drag on investment returns that Nobel Prize winner Daniel Kahneman, an Israeli American, advised Israel’s Pension Authority to send out statements once a quarter instead of once a month. Since when Israel’s pensioners don’t get their statements, they don’t do stupid things to their accounts.

So what are those behaviors that are so costly to investment returns? Please watch this five minute long video produced by Independence Advisors.

In a nutshell, the emotional reactions (such as herding) that had helped our hunter-gatherer forebears survive so well and thus are hard-wired into our brains are literally hazardous to successful investing. In a way, the value of an advisor like myself is to separate your emotions from your money.

Assessment

So, how does this relate to physicians and other medical professionals; better or worse?

Conclusion

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And Related Influential Thought-Leaders

  • Dr. Brad Klontz CSAC CFP®
  • Dr. Ted Klontz PsyD
  • Dr. Eugene Schmuckler MBA MEd CTS
  • Dr. Kenneth Shubin-Stein FACP CFA
  • Dr. David Edward Marcinko MEd MBA CMP™

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doctor

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James O. Prochaska PhD, Professor of Psychology and Director of the Cancer Prevention Research Center at the University of Rhode Island, developed the Trans-Theoretic Model of Behavior Change [TTM] which has been evolving since in 1977. Nominated as one of the five most influential authors in Psychology, by the Institute for Scientific Information and the American Psychological Society, Dr. Prochaska is author of more than 300 papers on behavior change for health promotion and disease prevention.

TTM Stages of Change

In his Trans-Theoretical Model, behavior change is a “process involving progress through a series of these stages:

  • Pre-Contemplation (Not Ready) – “People are not intending to take action in the foreseeable future, and can be unaware that their behavior is problematic”
  • Contemplation (Getting Ready) – “People are beginning to recognize that their behavior is problematic, and start to look at the pros and cons of their continued actions”
  • Preparation (Ready) – “People are intending to take action in the immediate future, and may begin taking small steps toward behavior change”
  • Action – “People have made specific overt modifications in changing their problem behavior or in acquiring new healthy behaviors”
  • Maintenance – “People have been able to sustain action for a while and are working to prevent relapse”
  • Termination – “Individuals have zero temptation and they are sure they will not return to their old unhealthy habit as a way of coping”

Relapse

In addition, researchers conceptualized “relapse” (recycling) which is not a stage in itself but rather the “return from Action or Maintenance to an earlier stage.” In medical care, these stages of behavior change have applicability to anti-hypertension and lipid lowering medication use, as well as depression prevention, weight control and smoking cessation.

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Psychology

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Uniting Psychology and Financial Behavior

More recently, validating the emerging alliance between psychology (human behavior) and finance (economics) are two Americans who won the Royal Swedish Academy of Science’s 2002 Nobel Memorial Prize in Economic Science. Their research was nothing short of an explanation for the idiosyncrasies incumbent in human financial decision-making outcomes.

Enter Kahneman and Smith

Daniel Kahneman, PhD, professor of psychology at Princeton University, and Vernon L. Smith, PhD, professor of economics at George Mason University in Fairfax, Va., shared the prize for work that provided insight on everything from stock market bubbles, to regulating utilities, and countless other economic activities. In several cases, the winners tried to explain apparent financial paradoxes.

For example, Professor Kahneman made the economically puzzling discovery that most of his subjects would make a 20-minute trip to buy a calculator for $10 instead of $15, but would not make the same trip to buy a jacket for $120 instead of $125, saving the same $5.

in vitro and in-vivo Economics

Initially, in the 1960’s, Smith set out to demonstrate how economic theory worked in the laboratory (in vitro), while Kahneman was more interested in the ways economic theory mis-predicted people in real-life (in-vivo). He tested the limits of standard economic choice theory in predicting the actions of real people, and his work formalized laboratory techniques for studying economic decision making, with a focus on trading and bargaining.

Later, Smith and Kahneman together were among the first economists to make experimental data a cornerstone of academic output. Their studies included people playing games of cooperation and trust, and simulating different types of markets in a laboratory setting. Their theories assumed that individuals make decisions systematically, based on preferences and available information, in a way that changes little over time, or in different contexts.

University of Chicago

By the late 1970’s, Richard H. Thaler, PhD, an economist at the University of Chicago also began to perform behavioral experiments further suggesting irrational wrinkles in standard financial theory and behavior, enhancing the still embryonic but increasingly popular theories of Kahneman and Smith.

Laboratory

Other economists’ laboratory experiments used ideas about competitive interactions pioneered by game theorists like John Forbes Nash Jr., PhD, who shared the Nobel in 1994, as points of reference.

Assessment

But, Kahneman and Smith often concentrated on cases where people’s actions departed from the systematic, rational strategies that Nash envisioned. Psychologically, this was all a precursor to the informal concept of life or holistic financial planning. Kahneman was awarded the Medal of Freedom, by President Barack Obama, on November 20, 2013.

READ: Behavioral Economics and Psychology DEM

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The Impact of Gratitude on Financial Behavior

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Overspending? Try a Little Gratitude 

By Rick Kahler MS CFP® http://www.KahlerFinancial.com

Rick Kahler MS CFPDo you want to more easily change your over-spending behavior? According to some new research, maybe all you need is a bit of gratitude.

Gratitude

Before you brush this idea aside as just another “feel good” theory, you may want to consider a 2013 study that suggests practicing gratitude is a powerful way to increase your happiness and decrease temptations. Northeastern University’s David DeSteno led the research project, which was published in June 2014 in the journal Psychological Science.

Logic versus Emotions

Many of us believe we ought to make decisions, especially financial ones, logically rather than emotionally. We assume emotions get in the way of decision-making, so we try to set them aside. We may think the best way to resist temptation, such as wanting to buy something we can’t afford, is to use self-control to clamp down our emotions.

The Research?

Yet research has shown that emotions play a significant role in all our decision-making. Some of that research is discussed in an article by Ray Williams published September 25, 2011, in Psychology Today.

Trying to ignore our emotions and make cold and calculating decisions is fear-based behavior. The gratitude research, however, suggests that emotions can be used instead to help us resist temptation. Perhaps being less fearful and more grateful can actually produce better decisions.

The Study

DeSteno’s study gave 75 participants a classic test of their financial self-control. They were told they could have either $54 right now or $80 in 30 days. Before they made their decision, the researchers put the participants into one of three emotional states: grateful, happy, or neutral.

The Results

Those who were either happy or neutral showed a strong preference for taking the $54 now. The fact that by waiting 30 days and getting $80 they would receive a one-month return of 48%, which is equal to an annualized return of 576%, wasn’t even a consideration. Behavioral economists tell us this is normal. Our brains are generally wired to “kill and eat.” Having something now, even though it’s less, is better than having more later, even if it will be much more. That is some strong wiring!

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mind-investing-behavioral-finance

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The Surprise

However, the surprise was that the people in the state of gratitude were much more likely to wait 30 days to receive the $80. Results also showed that the more gratitude the participants reported feeling, the more willing they were to wait for the larger gain.

The Grateful Difference

One conclusion of the study is that just cultivating the emotion of happiness isn’t enough to make wise financial decisions. It is specifically the emotion of gratefulness that makes a difference. According to one of the study’s authors, Professor Ye Li, this research “. . . opens up tremendous possibilities for reducing a wide range of societal ills from impulse buying and insufficient saving to obesity and smoking.”

We don’t know why gratitude has this effect. Psychologist Dr. Jeremy Dean, in a June 18 post at PsyBlog about the research, says, “. . . it may be because it makes us feel more social, co-operative and altruistic. In other words: gratitude may make us feel less selfish, which gives us more patience.”

Personally, I wonder whether another possibility may be that feeling gratitude reminds us of how much we already have, which tends to reduce our desire to get something more.

Assessment

If you’d like to do some experimenting of your own, consider practicing some gratitude exercises. Dr. Dean describes some at PsyBlog. These may be as simple as making daily lists of things you have to be grateful for. It’s possible that fostering gratitude could do more than just promote happiness. It might even change the way you spend and invest.

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Nine Psychological Reasons We Do Dumb Things

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Yep – Even the Smart Folks!

By Lon Jefferies MBA CMP® CFP®

Dr. David Edward Marcinko MBA MEd CMP®

Lon Jeffries

In the Business Insider, Mandi Woodruff describes nine mental blocks that cause smart people to do dumb things. Review the list and itemize the factors that have negatively impacted your finances.

The Factors

  • Anchoring happens when we place too much emphasis on the first piece of information we receive regarding a given subject. For instance, when shopping for a wedding ring a salesman might tell us to spend three months’ salary. After hearing this, we may feel like we are doing something wrong if we stray from this advice, even though the guideline provided may cause us to spend more than we can afford.
  • Myopia (or nearsightedness) makes it hard for us to imagine what our lives might be like in the future. For example, because we are young, healthy, and in our prime earning years now, it may be hard for us to picture what life will be like when our health depletes and we know longer have the earnings necessary to support our standard of living. This short-sightedness makes it hard to save adequately when we are young, when saving does the most good.
  • Gambler’s fallacy occurs when we subconsciously believe we can use past events to predict the future. It is common for the hottest sector during one calendar year to attract the most investors the following year. Of course, just because an investment did well last year doesn’t mean it will continue to do well this year. In fact, it is more likely to lag the market.
  • Avoidance is simply procrastination. Even though you may only have the opportunity to adjust your health care plan through your employer once per year, researching alternative health plans is too much work and too boring for us to get around to it. Consequently, we stick with a plan that may not be best for us.
  • Confirmation bias causes us to place more emphasis on information that supports the opinion we already have. Consequently, we tend to ignore or downplay opinions that don’t mirror our own, leading us to make uninformed decisions.

NOTE: A recent interesting example of the confirmation bias is the case of David Rosenberg, who is one of the most well-known perpetual bears on Wall Street. In October, Mr. Rosenberg’s analysis forced him to warm to the current investment environment. His fans and followers, rather than appreciating his research and ability to adjust to new information, criticized him for changing his opinion.

As it turned out Mr. Rosenberg had fans not because of his expert analysis, but because he added intellectual heft to his followers pessimism and quasi-political desire for the system to collapse. Their view was that things were in permanent decline and his analysis, charts, and voice added respectability to their pre-existing bias. Mr. Rosenberg has now lost his fan base not because he was wrong for the last four years, but because he changed his mind.

head

  • Loss aversion affected many investors during the crash of 2008. During the crash, many people decided they couldn’t afford to lose more and sold their investments. Of course, this caused the investors to sell at market troughs and miss the quick, dramatic recovery.
  • Overconfident investing happens when we believe we can out-smart other investors via market timing or through quick, frequent trading. Data convincingly shows that people who trade most often underperform the market by a significant margin over time.
  • Mental accounting takes place when we assign different values to money depending on where we get it from. For instance, even though we may have an aggressive saving goal for the year, it is likely easier for us to save money that we worked for than money that was given to us as a gift.
  • Herd mentality makes it very hard for humans to not take action when everyone around us does. For example, we may hear stories of people making significant profits buying, fixing up, and flipping homes and have the desire to get in on the action, even though we have no experience in real estate.

Assessment

The good news is that being aware of these tendencies can help us avoid mistakes. We’ll never be perfect, but avoiding detrimental decisions based on mental prejudices can give us an advantage in our financial and retirement planning efforts.

Conclusion

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On Our Financial Comfort Zones

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Exploring the Range

By Rick Kahler CFP® http://www.KahlerFinancial.com

Rick Kahler CFPTry to imagine the enormous range of possible financial conditions in which human beings can live. At the lowest end is bare subsistence—the minimum food and shelter possible to sustain life. At the highest end is unlimited wealth—multi-billionaires with more than they, their children, and their grandchildren could possibly spend.

Think: Abraham Maslow’s hierarchy of needs.

The Rest of Us

Most of us, including doctors of course, live in relatively narrow bands somewhere in between these extremes. In Wired for Wealth, we describe these bands as “financial comfort zones.”  People who share a financial comfort zone tend to have similar incomes, lifestyles, spending and savings habits, and beliefs about money.

For those growing up in wealthy families, “normal” may include private schools, international travel, live-in household help, and expectations of an Ivy-League education followed by a lucrative career.

Those growing up in families with limited incomes will inhabit a much lower financial comfort zone. Their “normal” might include shopping at thrift stores, squeaking by from month to month, and having little or no expectation of higher education.

In both cases, the expectations people grow up with tend to keep them in their financial comfort zones. These zones are artificial financial boundaries that we impose on ourselves, and they are not necessarily defined by what we can or cannot afford. Yet we become uncomfortable if we move too far outside them.

Expanding the Zone

Certainly, people can and do expand their financial comfort zones. Children who grow up in low-income families, for example, may be able to get an education and go on to careers that bring them financial success far beyond that of their parents.

The real problems arise when circumstances unexpectedly push people out of their financial comfort zones.

Out of the Zone

I once had a client couple inherit several million dollars. They had no idea Mom had that much money. All at once, they had the means to move into a much higher financial comfort zone. Yet their reaction was depression. They came into my office asking, “What is wrong with us?” We spent some time exploring their money beliefs and discovered their number-one money script was “Money we didn’t earn isn’t worth having.” Moving slowly out of their financial comfort zone thru their-own efforts would have been fine. Being shoved out of it by an unearned inheritance was a challenge.

It’s no wonder that many people, coming into unexpected wealth, unconsciously feel a need to get rid of it. It’s one way to get back into the familiar zone where they know how things work, they are comfortable, and they belong.

Solo Doc

The Higher Zone

The same thing can happen to those in higher financial comfort zones. Suppose a high-earning medical or professional couple, who are accustomed to an affluent lifestyle, lose nearly half their net worth in an economic downturn. Then; one of them is laid off. They aren’t going to starve. In fact, they could scale back their spending a great deal and still live perfectly comfortably.

Yet this may not seem like an option to them. Changing their financial circumstances would move them out of the place they belong. It’s possible they may go into debt or spend down the assets they do have left, jeopardizing their financial future, in order to maintain a lifestyle that keeps them in their financial comfort zone.

Assessment

Ironically, this couple would have a better chance of returning to their financial comfort zone if they were willing to live below it until their financial circumstances improved. Choosing to live at the low end of your financial comfort zone so you can invest for the future is one of the most important ways to build long-term financial independence and lasting financial comfort.

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Research shows the financial industry attracts more than its share of charming, manipulative egotists. Or, does it?

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Assessment

Here is what to watch for:

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Publications Related to Behavioral Finance, Economics and Money

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Interesting Articles by Dan Ariely PhD

NOTE: Dan is the Irrational Economist: He blogs at: http://danariely.com/

By Staff Reporters

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Doctors and Money “Disorders”

Behavioral Finance –  Are You Guilty?

By Rick Kahler MS CFP® ChFC CCIM www.KahlerFinancial.com

As a young adult, what could you spend money on that would be a wise investment in your financial future? A home? Medical school education? A money management class?

Well, all of these may be good ideas, but there’s something else you can buy that could make an even greater difference in your long-term financial health: counseling.

Behavioral Finance

What does psychological counseling have to do with money? Sometimes; a lot!

For example, I was recently interviewed by a reporter for an article about money disorders. The conversation reminded me just how many problems can result from dysfunctional money beliefs and behaviors. Money disorders can impair people’s functioning and disrupt their lives just as significantly as disorders like alcoholism or other addictions.

Common Maladies

Some common money disorders include the following:

  • Compulsive Spending is a consuming focus on spending. It can include buying things you can’t afford as well as shopping where no money is actually spent
  • Financial Enabling is a codependent attempt to help others that actually does more harm than good. A pattern of bailing kids out financially is a good example.
  • Hoarding is compulsively buying and storing things that you don’t need or will never use.
  • Financial Infidelity is keeping money secrets (such as spending, saving, or investment mistakes) from your partner because you would be ashamed to have them find out.
  • Financial Incest is inappropriate sharing of worries or financial details in ways that violate the boundaries between children and adults.
  • Workaholism, especially medical professionals, is a consuming focus on work or earning to a point of damaging your relationships.
  • Under-spending is frugality taken to extremes, such as inadequate spending on health care, nutrition, shelter, or clothing even when you can afford them.

Not about Money

How many of the above “disorders” are you guilty of?

All these disorders have one thing in common: fundamentally, they aren’t about the money. A given pattern of behavior around money can be someone’s unconscious response to emotional pain, in the same way addiction or anger might be.

For that particular person, the money behavior may just happen to be the medicator that works to cope with deep emotional stress. While one person may find relief in alcohol or drugs and another may find it in work, someone else might use shopping or hoarding as a way to feel better and function in the world.

An Addiction?

Just like addictions, however, money disorders only relieve pain for a short time. In the long term, they only cause more pain. The result is an escalating cycle of destructive behavior that has many negative consequences, including financial ones.

Rag Mags

To see how emotional health and financial health are linked, all you have to do is read a celebrity magazine or look around at the people you know. I’ve seen high-earning doctors and other medical professionals who have a negative self-worth because they can’t control their spending. We all know people who bounce from one financial mess to another, never seeming to learn from their money mistakes. Some very capable and intelligent doctors struggle financially and in their careers because of emotional issues that have nothing directly to do with money.

Counseling

Counseling to resolve emotional issues may seem to be a low-priority expense that comes far down the list after basic needs like housing, food, and transportation. Yet for anyone who struggles to overcome destructive patterns of behavior—even those that aren’t directly about money—counseling can pay off in very real monetary ways.

Assessment

Emotionally healthy and confident people make better choices about relationships, careers, and other major aspects of their lives. They also make better choices about money. This is why counseling is more than an investment in your emotional health. It can also make a measurable difference in your financial health.

Conclusion

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On Financial Therapy Rising

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Uniting Financial Planning and Behavioral Psychology

By Rick Kahler MS CFP® ChFC CCIM www.KahlerFinancial.com

The driver of the van that was to take me from the University of Missouri to the St. Louis airport asked where I was from. When I said, “Rapid City” and we struck up a conversation about his childhood trip to the Sturgis Rally. At one point he asked me, “What were you doing visiting MU?”

A Topic at the Financial Therapy Association (FTA) Conference

There I explained I had attended the third annual Financial Therapy Association (FTA) Conference. There was a silence. Then he continued talking about his memories of visiting the Black Hills.

Bringing up the topic of financial therapy tends to leave people speechless. It isn’t a common term. Plus, it combines two topics that most people want to avoid: therapy and finances. Put them together, and you have a real conversation killer.

Fortunately, there was plenty of conversation for the 85 professionals and students at the three-day FTA conference. For those attending for the first time, it was a “coming home” experience.

Mental Health Needs

Financial therapy addresses a need that until recent years most financial and mental health professionals didn’t talk about or didn’t even know existed. It’s the unconscious and unspoken thoughts, beliefs, and feelings around all things financial. Certified Financial Planners® aren’t required to have training in even basic communication skills, much less the more complex fundamentals of psychology or neuroscience.

Likewise, therapists and psychologists aren’t taught to deal with money, either in working with clients or in managing their own businesses.

As a result, neither profession provides the tools to address clients’ problematic and often self-destructive beliefs and behaviors around money. Destructive behaviors around money usually aren’t about the money.

For this reason, giving people more information about how money, investing, or financial planning works isn’t enough.

Financial Psychology

The exploration of financial psychology or emotion and money isn’t new. Dr. Jacob Needleman and Olivia Mellan were among the mental health pioneers who began raising questions around the psychological side of money in the 1990’s. About the same time, two financial planners, George Kinder and Dick Wagner, co-founded a leaderless group of financial planners, coaches, and therapists called the Nazrudin project to explore the emotional side of money. The Nazrudin project, which still meets annually, spawned scores of books, courses, and organizations raising the awareness and skill level of financial professionals and therapists.

The Nazrudin project was the primary influence that gave me, along with others, the idea of uniting financial planning with experiential therapy. I began referring to it as financial therapy after hearing the term from therapist Bari Tessler.

Financial Therapy

Typically, financial therapy involves a client-centered financial planner (typically only compensated by fee for service), and a therapist or psychologist, that conjointly work with clients. In my experience, this process helps clients who are in some way financially stuck make significant progress.

Academia Required

Link: www.CertifiedMedicalPlanner.org

The one thing missing in the evolution of financial therapy until recently was the involvement of academia. For the first time, the FTA unites academics, therapists, and financial planners in a common pursuit of defining and developing the concept of financial therapy. This is essential if financial therapy is to become a profession.

It may be some time before we see practitioners with advanced degrees in financial therapy. Before that time comes, the FTA has a lot of work to do, including coming up with a scholarly definition of financial therapy.

Assessment

In the meantime, Jeff Zaslow, who reported on our first financial therapy workshop in 2003 for The Wall Street Journal, wrote that it “combines experiential therapy with nuts-and-bolts financial planning.” As we work to foster the emerging profession of financial therapy, that’s still an accurate and effective way to describe it.

Conclusion

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Physicians and Discount or On-Line Brokerages

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Why are Doctors and Investors Eschewing Full Service Brokers?

By Dr. David Edward Marcinko MBA CMP™

[Founder and CEO] www.CertifiedMedicalPlanner.org

There are many studies that show that active trading garners inferior results to a longer term buy and hold type of strategy.

The UC-Davis Study

One of the most publicized recently was conducted by a UC-Davis team led by Dr. Terrance Odean. The study examined the actual tracing activity of thousands of self-directed accounts at a major discount brokerage over a six-year period. The results were clear. Regardless of trading level, most of the accounts underperformed the market and showed that the higher the number of trades, the worse the result.

Link: http://faculty.haas.berkeley.edu/odean/

Ego Driven

In addition to cost savings, discounters appeal to one’s ego for business. Everyone wants to feel like a smart investor. There is also a strong appeal to one’s sense of control. Hiring a professional advisor should not result in losing these feelings, but should solidify them. And, advice to sell has a far greater impact on investment results than the cost of a purchase trade as long as the level of trading is kept at a prudent level.

Avoidance of Sales Pressure

The final reason people turn to discount and on-line brokerages is to avoid sales pressure.  Unlike the stereotypical stockbroker or financial advisor [FA], no one calls to push a particular stock.  Instead, sales pressure is created within the mind of the investor.

Assessment

By maintaining a steady flow of information about stocks and the markets to the account holders, brokerages keep these issues in the forefront of the investor’s minds. This increases the probability that the investor will act on the information and execute a trade. Ironically, this focus on trading is one of the very conflicts investors are trying to avoid by fleeing a traditional full service broker.

Conclusion

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A Simple Formula For Financial Sobriety

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On Changing Financial Behaviors

By Rick Kahler MS CFP® ChFC CCIM www.KahlerFinancial.com

From time to time I offer financial courses through Community Education of the Black Hills. Classes on the fundamentals of making good investments and how to do your own financial planning usually fill quickly.

But, a class on “financial sobriety”—how to change your psychological behaviors around money and begin making wiser money decisions—had only one person sign up. Based on my 30 years of financial advising, this wasn’t a big surprise.

The Research

Research tells us 70% of US citizens have no savings and live month to month or are insolvent. Only 9% have saved over $100,000 and just 3% over $500,000. The stats for medical professionals are not so transparent.

Why is this? The simple answer is Americans have a significant resistance to saving, including some doctors, according to ME-P Editor-in-Chief, Dr. David Edward Marcinko FACFAS MBA CMP® www.CertifiedMedicalPlanner.org

Mathematically, the solution to this is very simple. Out of every dollar earned, do this: First, pay taxes. Second, save and invest 20% or more. Third, live on the rest. This formula has a high probability of successfully creating financial independence.

So, why are fewer than one in 10 Americans able to follow this simple formula? The answer to that isn’t so simple.

Psychological Responses

The first response to these options is often, “I can’t.” Non-savers tell themselves there is nowhere to cut. When put in context of maintaining their current lifestyle, this is true—and therein lies the problem. When you’re living month to month, becoming a saver inherently means either reducing your lifestyle or increasing your income.

Unfortunately, too many people vaguely intend to start saving when their income goes up. This is backwards. Focusing instead on reducing your lifestyle is what creates the habit of saving.

  • For some people, downsizing a lifestyle can mean switching kids from private to public schools or selling expensive cars and homes.
  • For others, downsizing can mean getting rid of cable TV, buying generic brands, and shopping at garage sales instead of Walmart. Most budgets have room for at least a few small cuts. We just can’t see the options, because our brains tell us that reducing our lifestyle will be a fate worse than death.

It may seem that a lifestyle reduction would be a lot easier for high income earner. Yet I’ve seen those earning $750,000 have as much trouble saving $10,000 a year as those earning $50,000. The self-talk and reasons why it’s impossible to cut spending are exactly the same.

Not about Money

It’s not about the money. It’s never about the money. It’s not that most non-savers don’t know the solution to saving more; it’s that they don’t like the solution. We cannot change what we refuse to confront.

It takes a lot of courage to admit you have to change and then take action to actually put a plan into motion. It can feel overwhelming, embarrassing, and fearful. It’s hard saying goodbye to the old lifestyle and the trappings we come to enjoy.

Adaptable Humans

Fortunately, the difficult times are temporary. Humans are very adaptable. Before long you will settle into the new “normal.” You will discover you can be just as happy with your new lifestyle as you were in the old. The anxiety of losing that lifestyle will be replaced with the satisfaction of watching your savings and investments grow, knowing you will someday be able to support yourself without working.

Assessment

Eventually, you will experience much less anxiety than you did when you were living in denial. Knowing you have enough savings to see you through a job loss or other financial calamity is a real anxiety buster.

You may even choose not to increase your lifestyle as your income increases. You’ll be too busy enjoying the financial serenity, satisfaction, and joy that comes with living on less than you earn and building financial independence.

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As With Medical Decisions – Human Emotions Play a Role in Investment Advice

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Appreciating Transferrable Applications in Behavioral Finance

By Sidney A. Blum CFP® CPA/PFS ChFC

By Dr. David E. Marcinko MBA

Whether making medical decisions or financial decisions, both are influenced by emotions. The role of emotions, when making financial decisions, has transferable application in the world of medical decisions.

What Role Should Emotion Play in Financial Advice?

Financial advisors know that one of the most important components of providing financial advice is discussing client goals. Inherently your goals are tied to how you see yourself and in what ways you see your money and net worth as a reflection of yourself. This aspect of your financial life is usually tied to emotions based on perceived positive or negative experiences in your life.

Financial advisors find that they expend considerable time and energy addressing emotions and negative reactions to events in clients’ lives. The goal is to move the focus toward positive steps for reaching client goals. As with other aspects in your life, emotional reactions can distract you from well reasoned actions that benefit in the long run. This is the reason it is beneficial to engage a financial professional to guide you through your financial life circumstances with advice driven by goals rather than emotional negative reactions.

Emotional Intelligence

The use of Emotional Intelligence is a learned skill set. Financial Advisors who are skilled in understanding the four basic emotions that guide them and their clients will find they are more successful in their chosen work!

The Four Basic Emotions

The four emotions are: Glad, Sad, Mad and Scared. These four basic emotions are neither good nor bad – they just “are”!

It is one or more of these emotions that help determine just how “risk adverse” a client will be. It is absolutely necessary for a financial advisor to be aware of the client’s emotional state, whether the client is aware or not. People react emotionally to market downturns. They are probably scared first, but also mad and sad as the market changes. They may get caught up in the market’s emotional swings and lose sight of their own goals and strategy. They think it will always stay that way. Or in an upturn, they believe the market will always stay up. They get caught up in the euphoria of “glad” and again lose sight of their goals and strategy. Many people get caught up in the high market frenzy and end up buying shares that are overpriced; even doctors.

Examples:

Pulling out of the market to protect temporary downside losses in value also means not participating in the upside, which eventually occurs. From the major downturn in the spring of 2009 to the fall of 2009, the market recovered better than 35%. Those who pulled out of the market and stayed out missed out on that portion of their own portfolio’s recovery. Due to reacting emotionally, people buy in up market and sell in a down market – the opposite of what garners them a good return.

Another difficulty is that people lose sight of the fact that a fund investment is in actual companies – some of which survive and some don’t. The nature of the investment market is that there are no guarantees on return of investment. A certain amount of volatility is normal. It is the price you pay for the opportunity of garnering a higher return than with “safe” investments.

And, how safe are “safe” investments? If your “safe” investments are earning 1% while inflation is running at 3% as is the case in 2012, you are losing purchasing power. If the bucket is leaking slowly, it can still end up empty!

So when you feel “glad” about a safe investment, what may be a good feeling may turn out to be a bad investment.

How Advisors Help Clients

How does an advisor help to keep their clients’ focus on the positive steps that can be taken to meet goals instead of reacting solely to current market conditions? How does advisor keep from getting involved in the client’s negative and unproductive emotional reactions?

Financial advisors have seen these situations before, but clients may not be aware that financial markets tend to return to the norm and provide a positive return in the long run. By helping provide a perspective on how the market normally behaves; the focus can be shifted from how the market currently stands, a temporary fluid condition, to the longer range behavior of markets. This provides a sense of stable emotions that allows the client and the advisor to make better financial decisions.

Non-Monetary Goals?

A financial advisor can also help you realize that financial planning is more than investments and that some goals are not solely monetary. It is less stressful and far more productive for people to keep their eyes on their goals, not on the dollar value of their portfolio. In the end, your net worth is not the same as your self‐worth.

Assessment

Because emotions play a significant role in all decisions we make, a major part of an advisor’s job is to help the client keep their focus on the positive steps that can be taken to meet those goals instead of reacting based solely on emotions!

About the Author

Sid graduated from the University of Illinois with a degree in accounting and has been practicing as a CPA since 1975 and financial advisor since 1987. Sid received the CERTIFIED FINANCIAL PLANNER certification in 1987 and in 1988, received the AICPA Certificate of Education Achievement in Personal Financial Planning. In 1989, Sid received the designation of Chartered Financial Consultant (ChFC) and in 1991 the AICPA specialty designation of Personal Financial Specialist (CPA/PFS).

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Conclusion

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An Update on Maslow’s Hierarchy of e-Needs for Modernity

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Understanding the New-Wave Social Media that Fuels Them

[By Staff Writers]

All medical professionals, and some FAs and behavioral economists, realize that Maslow’s hierarchy of needs is often portrayed in the shape of a pyramid, with the largest and most fundamental levels of needs at the bottom, and the need for self-actualization at the top.

So, this infographic takes Maslow’s theory and looks at the electronic social media tools that fulfill these needs.

Source: ticsyformacion.com

Assessment

Yet, another new-paradigm assessment of social media for doctors, financial advisors … and us all.

 

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Conclusion

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***

For Financial Success – Doctors Must Outsmart their Brains

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On Behavioral Economics 101

By Rick Kahler CFP® MS ChFC CCIM http://www.kahlerfinancial.com

By Dr. David Edward Marcinko MBA http://www.CertifiedMedicalPlanner.org

How’s this for a convincing excuse not to save for retirement? “I can’t help it. The human brain is programmed for financial failure.”

Why?

Emotional Decisions

An estimated 80 percent of our decisions are made emotionally. As all doctors are aware, our brain is divided into three sections. The upper brain, or cerebral cortex, is where we reason. The middle brain, or limbic system, is where we react to emotional impulse. The lower brain – basal ganglia – is what regulates the operations of the body.

Limbic System

The limbic system, where our emotions reside, functions to move us toward pleasure or away from danger. Feelings like fear or anger can cause us to move away from a perceived danger, while feelings of joy or pleasure can impel us toward a perceived benefit or reward. This aspect of our brain serves us very well when it comes to physical danger or life-enhancing decisions like choosing a mate. It isn’t quite so much help when we need to make financial decisions.

The Scenario

Suppose you and your spouse are talking about spending $5,000 on a trip to the Bahamas. Your middle brain lights up. It sees you sitting on a beach, it feels the light breeze twirling your hair, it hears the sound of the waves rolling onto the sand, and it can practically taste the Piña Colada you’re sipping.

Now, suppose you’re discussing putting that $5,000 into an IRA instead. What does your limbic system see, hear, feel, or smell? You writing a check? A brokerage statement? There’s no particular pleasure response for your emotional brain to get excited about. No wonder it’s going to urge you away from the IRA and toward the trip to the Bahamas.

Decision Making

When we’re faced with decisions, the option with the greatest emotional payoff tends to win. This is how our brains are wired to make financial decisions in favor of our short-term pleasure rather than the delayed gratification that is in our long-term best interest.

The secret to overcoming that self-defeating programming is to give our limbic system something to get excited about that supports saving for the future. Successful savers and physicians and all investors learn to link emotional rewards to their financial goals.

On Choices Revisited

Let’s take another look at the choice between an immediate tropical vacation and putting money into an IRA. Someone committed to investing for the future may imagine the same tempting beach scene. What they do, however, is see it happening once a year, or even every day—in the future. They imagine themselves enjoying that beach as one of the rewards of saving for their financial independence.

It’s also possible to trick the limbic system with negative images. Another saver might vividly imagine her-self as a bag lady, living out of garbage cans and sleeping on park benches, if she doesn’t write that check to her IRA. This isn’t nearly as much fun as imagining situations that reward investing, but it has the same effect of adding emotional impact to a financial decision.

In either case, the goal is to create an emotional charge from imagining the IRA contribution that is stronger than the image of spending the money today. The scene with the greatest emotional impact wins.

This is one reason it’s important for us to spend some time defining our life aspirations. Having clear images of what we want in the future makes it easier to imagine ourselves there. It helps us link strong emotional rewards to mundane activities like writing a check to an IRA.

Assessment

The human brain may be programmed for financial failure, but we have the ability to change that programming. With a little effort, we can rewire our brains for financial success.

Conclusion

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Investing Behaviors That Leave Money on the Table

Are Physicians Guilty, Too?

By Rick Kahler, CFP®, MS, ChFC, CCIM

If you had half a million dollars for your retirement fund, and invested it in mutual funds, chances are you would leave $25,000 a year of potential income on the table. Over 20 years, that underperformance could cost you over $1,000,000 when you include reinvestment.

The Dalbar Study

This conclusion is based on a recent study by Dalbar, Inc. It found that mutual fund investors (individuals and investment advisors) consistently earn below-average rates of return. This group’s average annual rate of return for 20 years underperformed the average by over 5%.

The Results

The study concluded most of this underperformance has little to do with sound investment strategy and everything to do with psychological factors. It outlined several behaviors that contribute to poor investment decisions such as badly-timed buying and selling.

Lack of Diversification – Many investors try to reduce risk through diversification, but very few do it properly. They try to diversify by having several advisors, many brokerage companies, or different mutual funds. Using these strategies creates a false sense of security that one’s portfolio is diversified. Real diversification is having investments in many different asset classes, i.e., stocks, bonds, real estate, cash, commodities, absolute return, and international equivalents.

Anchoring – This is relating something to a familiar experience that isn’t necessarily true. For example, a financial salesperson may compare investing in an equity mutual fund to growing a tomato plant. You put in a little seed and watch your plant grow and grow, until one day you have a bushel basket of luscious tomatoes. It’s an appealing image, but it sets an unrealistic expectation of an equity mutual fund. Neither stocks nor tomato plants grow that steadily. Some don’t grow at all. Others grow overnight and then die just as suddenly. Some get wiped out by hail. And some thrive.

Media Reporting – Reacting to the financial news without a more in-depth examination can ruin the most sound investment strategy. Very few financial reporters have degrees in economics or finance. Most financial reporting is faddish, trendy, sensational, and shallow. Research suggests investors who shun or limit their intake of financial news do better than those who don’t.

Herding – This is the concept that the herd knows best. Few people want to be going east when the whole herd is heading west. This is especially true when the herd is panicking: selling out of fear that their investments are going to nothing or buying out of fear of being left behind. The most successful investors avoid stampedes.

Loss Aversion – This is placing more emphasis on avoiding loss than on the possibility of gain. It results in investors wanting their cake and eating it too by searching for an investment with a high return and low or no risk. Such investments don’t exist. When they discover this, many investors don’t invest at all. Others go into an investment expecting it won’t go down, then sell out at precisely the wrong time when it does.

Delusion – This is an attitude that “bad things only happen to others, but not me.” A deluded investor is one who holds onto an investment even when it’s apparent that it’s never coming back.

Narrow Framing – This is making a quick decision without gathering or being aware of all the facts and considering the implications. Usually, the investor doesn’t uncover “the rest of the story” until it’s too late and the financial damage is done.

Assessment

And so, are you guilty of any of the above investing behaviors? No one – not even doctors and medical professionals – wants to leave a sizeable amount of potential retirement income on the table. 

The best tool for getting more of that income into your pocket isn’t necessarily studying investment philosophy. It may be more important to learn more about your own behavior.

The Author

Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, is the founder and president of Kahler Financial Group in Rapid City, South Dakota. In 2009 his firm was named by Wealth Manager as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is a co-founder of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Learn more at KahlerFinancial.com

Conclusion      

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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Behavioral Finance for Doctors?

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On the Psychology of Investing [Book Review]

By Peter Benedek, PhD CFA

Founder: www.RetirementAction.com

Some of the pioneers of behavioral finance are Drs. Kahneman, Twersky and Thaler. This short introduction to the subject is based on John Nofsinger’s little book entitled “Psychology of Investing” an excellent quick read for all medical professionals or anyone who is interested in learning more about behavioral finance.

Rational Decisions?

Much of modern finance is built on the assumption that investors “make rational decisions” and “are unbiased in their predictions about the future”, however this is not always the case.

Cognitive errors come from (1) prospect theory (people feel good/bad about gain/loss of $500, but not twice as good/bad about a gain/loss of $1,000; they feel worse about a $500 loss than feel good about a $500 gain); (2) mental accounting (meaning that people tend to create separate buckets which they examine individually), (3) Self-deception (e.g. overconfidence), (4) heuristic simplification (shortcuts) and (4) mood can affect ability to reach a logical conclusion.

John Nofsinger’s Book

The following are some of the major chapter headings in Nofsinger’s book, and represent some of the key behavioral finance concepts.

Overconfidence leads to: (1) excessive trading (which in turn results in lower returns due to costs incurred), (2) underestimation of risk (portfolios of decreasing risk were found for single men, married men, married women, and single women), (3) illusion of knowledge (you can get a lot more data nowadays on the internet) and (4) illusion of control (on-line trading).

Pride and Regret leads to: (1) disposition effect (not only selling winners and holding on to the losers, but selling winners too soon- confirming how smart I was, and losers to late- not admitting a bad call, even though selling losers increases one’s wealth due to the tax benefits), (2) reference points (the point from where one measures gains or losses is not necessarily the purchase price, but may perhaps be the most recent 52 week high and it is most likely changing continuously- clearly such a reference point will affect investor’s judgment by perhaps holding on to “loser” too long when in fact it was a winner.)

Considering the Past in decisions about the future, when future outcomes are independent of the past lead to a whole slew of more bad decisions, such as: (1) house money effect (willing to increase the level of risk taken after recent winnings- i.e. playing with house’s money), (2) risk aversion or snake-bite effect (becoming more risk averse after losing money), (3) trying to break-even (at times people will increase their willing to take higher risk to try to recover their losses- e.g. double or nothing), (4) endowment or status quo effect (often people are only prepared to sell something they own for more than they would be willing to buy it- i.e. for investments people tend to do nothing, just hold on to investments they already have) (5) memory and decision making ( decisions are affected by how long ago did the pain/pleasure occur or what was the sequence of pain and pleasure), (6) cognitive dissonance (people avoid important decisions or ignore negative information because of pain associated with circumstances).

Mental Accounting is the act of bucketizing investments and then reviewing the performance of the individual buckets separately (e.g. investing at low savings rate while paying high credit card interest rates).

Examples of mental accounting are: (1) matching costs to benefits (wanting to pay for vacation before taking it and getting paid for work after it was done, even though from perspective of time value of money the opposite should be preferred0, (2) aversion to debt (don’t like long-term debt for short-term benefit), (3) sunk-cost effect (illogically considering non-recoverable costs when making forward-going decisions). In investing, treating buckets separately and ignoring interaction (correlations) induces people not to sell losers (even though they get tax benefits), prevent them from investing in the stock market because it is too risky in isolation (however much less so when looked at as part of the complete portfolio including other asset classes and labor income and occupied real estate), thus they “do not maximize the return for a given level of risk taken).

In building portfolios, assets included should not be chosen on basis of risk and return only, but also correlation; even otherwise well educated individuals make the mistake of assuming that adding a risky asset to a portfolio will increase the overall risk, when in fact the opposite will occur depending on the correlation of the asset to be added with the portfolio (i.e. people misjudge or disregard interactions between buckets, which are key determinants of risk).

This can lead to: (1) building behavioral portfolios (i.e. safety, income, get rich, etc type sub-portfolios, resulting in goal diversification rather than asset diversification), (2) naïve diversification (when aiming for 50:50 stock:bond allocation implementing this as 50:50 in both tax-deferred (401(k)/RRSP) accounts and taxable accounts, rather than placing the bonds in the tax-deferred and stocks in taxable accounts respectively for tax advantages), (3) naïve diversification in retirement accounts (if five investment options are offered then investing 1/5th in each, thus getting an inappropriate level of diversification or no diversification depending on the available choices; or being too heavily invested in one’s employer’s stock).

Representativeness may lead investors to confusing a good company with a good investment (good company may already be overpriced in the market; extrapolating past returns or momentum investing), and familiarity to over-investment in one’s own employer (perhaps inappropriate as when stock tanks one’s job may also be at risk) or industry or country thus not having a properly diversified portfolio.

Emotions can affect investment decisions: mood/feelings/optimism will affect decision to buy or sell risky or conservative assets, even though the mood resulted from matters unrelated to investment. Social interactions such as friends/coworkers/clubs and the media (e.g. CNBC) can lead to herding effects like over (under) valuation.

Financial Strategies

Nofsinger finishes with a final chapter which includes strategies for:

(i) beating the biases: (1) Understand the biases, (2) define your investment objectives, (3) have quantitative investment criteria, i.e. understand why you are buying a specific investor (or even better invest in a passive fashion), (4) diversify among asset classes and within asset classes (and don’t over invest in your employer’s stock), and (5) control your investment environment (check on stock monthly, trade only monthly and review progress toward goals annually).

(ii) using biases for the good: (1) set new employee defaults for retirement plans to being enrolled, (2) get employees to commit some percent of future raises to automatically go toward retirement (save-more-tomorrow).

Assessment

Buy the book (you can get used copies at through Amazon for under $10). As indicated it is a quick read and occasionally you may even want to re-read it to insure you avoid the biases or use them for the good. Also, the book has long list of references for those inclined to delve into the subject more deeply.

You might even ask “How does all this Behavioral Finance coexist with Efficient Market theory?” and that’s a great question that I’ll leave for another time.

More: SSRN-id2596202

Conclusion

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Dr. Somnath Basu on Financial Planning Client Expectations [PodCast]

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On Client Attitudes in the New Economy

In this encore podcast, Somnath Basu PhD examines how the recent economic turmoil has changed financial planning clients’ attitudes and expectations.

Dr. Basu is a popular ME-P contributor and thought-leader.

Assessment: http://www.youtube.com/watch?v=jzAkB8h5v3Q

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How Well Behaved Are Your Financial Decisions-Doctor?

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“Massively Confused Investors Making Conspicuously Ignorant Choices”

By Somnath Basu PhD, MBA

How well we make investment decisions depends in part on how reasoned or emotional the decision was. The greater the emotional content the more likely will be the mistake. It is useful for all of us to understand the emotional pitfalls of financial decision-making.

Financial Psychologists

An appropriately titled study by a financial psychologist Michael S. Rashes, “Massively Confused Investors Making Conspicuously Ignorant Choices” cites that the widespread phenomenon witnessed in the market, whereby several stocks with similar ticker symbols all went up in value when positive news was announced about any one of them.

Example: http://ideas.repec.org/a/bla/jfinan/v56y2001i5p1911-1927.html

A case in point is the parallel movement between two entirely unrelated stocks, MCIC (ticker symbol for the telecommunications firm, MCI, bought by Worldcom in 1997), and MCI (ticker symbol for the Massmutual Corporate Investors fund). The acquisition of MCI, the telecommunications firm, in 1997-8 caused an upward movement in its stock (MCIC). That movement was also closely correlated with the upward movement in the stock of Massmutual Corporate Investors (MCI), whose ticker symbol was the same as the telecommunications company’s name. Rampant confusion of this sort strongly supports the notion that irrationality, not rationality, rules the financial markets. Another noted scientist, B. Malkiel suggests that when it comes to investing, people generally follow their emotions, not their reason, their hearts, not their minds.

Behavioral Finance and Economic Gurus

This line of argument has been gaining credibility over the last decade or so, not only among behavioral finance experts, but also economists themselves, as well as stock market pundits and the population at large. There is a strong sense among all these groups that greed, exuberance, fear and herding behavior affect markets as much as or more than calculations of P/E ratios, profit projections, or market benchmarks. The bursting of the stock market bubbles of 2000 and 2008 only confirmed these long-held suspicions. As a result, widely used economic models based on rational investor behavior require some reevaluation and could be found to be unreliable at best and irrelevant at worst.

The Decision Biases

The following is only a partial list of the biases that may be induced in you if the financial decisions you make are based on emotion and not on reason. The list includes the bias name, a descriptive definition and an example of application error. Before closing that next trade you make, a good question to ask yourself is whether any of the biases from the list were included in your financial decision. If so, these decisions too need further evaluation.

1. Over-Confidence:

Over-estimating the chances of correctly predicting the direction of price changes!

Example: Attribute good outcomes (i.e., gains) to your skill while attributing bad outcomes (i.e., losses) to your bad luck.

2. Pride and Regret:

Investors often over-estimate their powers of discerning stock winners from losers. Some physicians and other investors (essentially, active traders) may rapidly sell and buy back stocks, in order to capture expected gains.

Example: Selling your winning picks early and holding onto losers hoping they rebound. Studies show that doing the opposite can increase your annual returns by 3-4%.

3. Cognitive Dissonance:

Suggests that investors experience an internal conflict when a belief or assumption of theirs is proven wrong

Example: It’s easier to remember your winning picks than your losing ones since the latter outcomes disagreed with your earlier beliefs.

4. Confirmation Bias:

Suggests that they try to seek out information that will help confirm their existing views whether those views be right or wrong.

Example: When you hear someone agreeing with your investment decision you feel that person is much more knowledgeable than one who disagrees with you.

5. Anchoring:

A phenomenon whereby people stay within range of what they already know in making guesses or estimates about what they do not know.

Example: The Dow Jones Industrial Average (DJIA), which grew from a value of 41 in 1896 to 9,181 in 1998, does not include dividends. They then value the index in 1998, including dividends, at a whopping 652,230. When asked, investors estimate the value of the DJIA would be if dividends were included, all were way off the mark, keeping their answers close to its familiar value of 9,181. The highest guesses came in at under 30,000, less than 5% of the actual value.

6. Representative Heuristics:

An over-reliance on familiar clues, such as past performance of a stock!

Example: most investors assume that the stock of a company with strong earnings will perform well and that the stock of a company with weak earnings will perform poorly. The law of large numbers suggests however that the exact opposite is much likelier to be true.

Conclusion

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NOTE: Somnath Basu is a Professor of Finance at California Lutheran University and the creator of the innovative AgeBander (www.agebander.com) retirement planning software.

 

 

Where Are We in the Life Cycle of Stock Market Emotions?

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An Opinion Poll

[By Staff Reporters]

According to behavioral economists and financial advisors like Brian Knabe MD CFP™ CMP™ people feel the pain of loss twice as much as they derive pleasure from an equal gain. Studies show that humans process investment losses using the same part of the brain that responds to mortal danger.

For example, a 10% loss in the market causes twice the emotion as a 10% gain would elicit, and the short time period involved in the “flash crash” of 2008-09 compounded this effect.

And so, we ask in this ME-P poll “Where Are We in the Life Cycle of Stock Market Emotions?”

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Beware Medical and Money Management ‘Groupthink’

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Helping Doctors Understand Peer Comparisons

By J. Wayne Firebaugh CPA, CFP® CMP™

By Dr. David E. Marcinko MBA, CMP™

Source: http://www.CertifiedMedicalPlanner.org

More than a few mutual, hedge and endowment fund managers have noted that they commonly compare their endowment and portfolio allocations to those of peer institutions and that as a result, allocations are often similar to the “average” as reported by one or more surveys/consulting firms.

One interviewed endowment fund manager expanded this thought by presciently noting that expecting materially different performance with substantially the same allocation is unreasonable. It is anecdotally interesting to wonder whether any “seminal” study “proving” the importance of asset allocation could have even had a substantially different conclusion. It seems likely that the pensions and funds surveyed in these types of studies have very similar allocations given the human tendency to measure one-self against peers and to use peers for guidance.

This is a truism in medicine as well as the financial services sector.

Understanding Peer Comparisons

Although peer comparisons can be useful in evaluating your portfolio, or your hospital or medical practice’s own processes, groupthink can be highly contagious and dangerous.

For historical example, in the first quarter of 2000, net flows into equity mutual funds were $140.4 billion as compared to net inflows of $187.7 billion for all of 1999. February’s equity fund inflows were a staggering $55.6 billion, the record for single month investments. For all of 1999, total net mutual fund investments were $169.8 billion[1] meaning that investors “rebalanced” out of asset classes such as bonds just in time for the market’s March 24, 2000 peak (as measured by the S&P 500).

Of course, physicians and investors are not immune to poor decision making in upward trending markets. In 2001, investors withdrew a then-record amount of $30 billion[2] in September, presumably in response to the September 11th terrorist attacks. These investors managed to skillfully “rebalance” their ways out of markets that declined approximately 11.5% during the first several trading sessions after the market reopened, only to reach September 10th levels again after only 19 trading days. In 2002, investors revealed their relentless pursuit of self-destruction when they withdrew a net $27.7 billion from equity funds[3] just before the S&P 500’s 29.9% 2003 growth.

Amateurs versus Professionals [is there such a thing?]

Although it is easy to dismiss the travails of mutual fund investors as representing only the performance of amateurs, it is important to remember that institutions are not automatically immune by virtue of being managed by investment professionals.

For example, in the 1960s and early 1970s, common wisdom stipulated that portfolios include the Nifty Fifty stocks that were viewed to be complete companies.  These stocks were considered “one-decision” stocks for which the only decision was how much to buy. Even institutions got caught up in purchasing such current corporate stalwarts as Joe Schlitz Brewing, Simplicity Patterns, and Louisiana Home & Exploration.  Collective market groupthink pushed these stocks to such prices that Price Earnings ratios routinely exceeded 50 [nothing in the internet age]. Subsequent disappointing performance of this strategy only revealed that common wisdom is often neither common nor wisdom.

The Bear Sterns Example

Recall that The New York Times reported on June 21, 2007, that Bear Stearns had managed to forestall the demise of the Bear Stearns High Grade Structured Credit Strategies and the related Enhanced Leveraged Fund.  The two funds held mortgage-backed debt securities of almost $2 billion many of which were in the sub-prime market.  To compound the problem, the funds borrowed much of the money used to purchase these securities.  The firms who had provided the loans to make these purchases represented some of the smartest names on Wall Street, including JP Morgan, Goldman Sachs, Bank of America, Merrill Lynch, and Deutsche Bank.[4]  Despite its efforts Bear Stearns had to inform investors less than a week later on June 27 that these two funds had collapsed. The subsequent fate of these firms, and the history of the past two years, need not be repeated to appreciate that the king surely had no clothes.

Assessment

What broader message lies in this post relative to such medical initiatives as P4P, various clinical quality improvement endeavors and benchmarks, hospital peer-review, PROs, Medicare compliance, etc?  

Conclusion

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References


[1]   2001 Fact Book, Investment Company Institute.

[2]   Id.

[3]   2003 Fact Book, Investment Company Institute.

[4]    Bajaj, Vikas and Creswell, Julie. “Bear Stearns Staves off Collapse of 2 Hedge Funds.” New York Times, June 21, 2007.

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners(TM)

The Economics of Stock Market Fear for Physicians

Panic Control and the Possibility of Severe Financial Degradation 

By Somnath Basu PhD, MBA [www.clunet.edu/cif]

[Director California Institute of Finance]

An experiential learning of mammoth proportions occurred several weeks ago in the financial markets. The absolute 10 minute freefall of the prices of stocks and bonds, without any pre-notification froze the hearts of many physicians and lay others both in, and outside, of the investment community. The possibility of a one trillion dollar loss had suddenly and unexpectedly turned real. It happened in a matter of minutes. This experience of panic, of the possibility of a severe economic degradation of life becoming immediately real, is like none other that most of us can ever remember experiencing. Even the 1987 crash happened over a large part of that Monday. Like then, this time too there is no known reason of why it happened, though attempts are being made to understand the cause(s). Whatever the reasons may be, it will not change the experience we had of the realization of the fear of a sudden and unexpectedly large loss.

Event Analogies

Before going deeper into the experienced fear, it is useful to provide some analogies to the event. If the meltdown in the financial markets of 2008 was like an earthquake, then this was like a severe aftershock. It is also similar to going down one of those severe roller coaster freefalls that some may consider very undesirable. Alternately, what makes a 30 year old physician be mostly unconcerned about his/her lack of retirement savings while a 60 year old doctor in the same poor condition is much more concerned. Obviously, the possibility of a lower quality of economic life is much more real for the elder than the younger. In such cases we would expect the fear of an economically degraded life to spur people to take preventive or remedial action.

Understanding Fear

To truly understand our responses to fear, we need to go deeper into our minds. According to behavioral psychologists and neurologists both, there are various segments within our mind. For example, one segments of our mind (the frontal lobe) is understood to process analytical tasks. Similarly, other parts of our brain (the older limbic system composed of mammalian and reptilian brains) react to and affect/control our emotions and fear. When we are faced with an immediate threat, this older system takes over control of our reactions and often drives us towards instinctive responses and will not, in general, make the analytically reasoned response. It is similar to learning about all the different ways we need to behave in the wild if we came across a bear. When people actually are faced by such a situation, they rarely remember all their learning and respond with their instincts. Those are the limbic responses. In other words, when threats are real, our emotional mechanisms will dominate our rational mind and we will react according to our older and longer existing nature.

Shocked Limbic System

Such was the effect of the financial freeform. In those 10 minutes the economic shock to our limbic system was the first of its kind, in terms of magnitude. While discussions are held about sudden unexpected losses, typically the impact of sudden huge losses in a very very short period of time is rarely thought of in very meaningful ways because the probability is so very low. This time, it did actually happen! We will bear some consequences which will begin playing themselves out slowly over this summer. For one, the investing nation will be much more circumspect about stocks and other volatile financial instruments. In a more technical way, our risk aversion as a nation will have suddenly increased. This will have an impact on both trading volume and security market prices and eventually on portfolio values. How younger physicians and other investors will react is less known.

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Assessment

Finally, there is one important lesson in behavioral finance for us all – and that is for medical professionals to find competent financial advisors and planners who can safely herald all people in these times. It also is probably an important point to understand why the portfolios of older physicians should consider safety of principal first whilst the younger ones focus on growing their wealth.

Editor’s Note: Somnath Basu PhD is program director of the California Institute of Finance in the School of Business at California Lutheran University where he’s also a professor of finance. He can be reached at (805) 493 3980 or basu@callutheran.edu. See the agebander at work at www.agebander.com

Conclusion

And so, your thoughts and comments on this ME-P are appreciated. Would anyone like to discuss neurotransmitters or chime in on the flight or fight response? Are these very human reactions any different for doctors? How about feelings of “fear” or stock-market “panic attacks?”

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Physicians and FAs Dealing with Debt Collaboratively

A Holistic Approach to Financial Health Planning

[By Somnath Basu; PhD, MBA]

Financial Advisers [FAs] often feel helpless in the face of fierce resistance from clients, especially doctors, to rein in their spending, stop living beyond their means and salt away more of their paychecks. Even worse, the financial services industry’s less discerning practitioners are enabling reckless behavior for fear of losing business.

Psychological MoJo

A huge part of the problem is psychological. Look no further than the emerging field of behavioral finance to explain why average Americans of all ages and walks of life feel pressure to keep up with their neighbor. The unfortunate result, of course, is that consumers max out their credit cards, tap equity lines of credit or consolidate loans in pursuit of the American Dream. But, in the process, they often fall victim to over-consumption and under-saving.

Bad Faith Lenders

Unscrupulous lenders are exploiting doctors and consumers with interest-only loans and variable-rate home buying without a down payment – the latter labeled in one recent headline as a car-dealer tactic on the new-home lot. Another gimmick ties a home equity loan to life insurance with the promise of zero premiums, albeit no escape from a lien on equity no matter how it’s sold to an unsuspecting public.

Debt Consolidation Issues

There’s also the issue of determining whether it’s prudent for physicians to consolidate their debt. Many online calculators use the current monthly payment figure as the basis for comparison against monthly payments after debt consolidation, which is erroneous since payments in subsequent periods aren’t compared. This flawed approach is enough to convince unwary people they should consolidate their loans, and in many cases, it justifies a resumption of conspicuous consumption – leading to a vicious cycle.

Need for Discipline

Before a Financial Advisor even gets through a doctor-client’s front door, chances are that the person they’re meeting with might require the services of a psychotherapist and/or credit counselor (or require such a recommendation) to examine the root causes of their propensity for reckless spending and suggest a need for financial discipline.

Wants versus Needs

There must be a clear understanding of the difference between needs (i.e., retiring with peace of mind) and desires (i.e., living the high life), and a willingness to change. It means not eating out five times a week or financing a $75,000 kitchen remodeling makeover, cutting back on entertainment, or making more than the minimum payment on credit card balances. It means not rushing out to buy a house or perhaps finding a local college for children to attend and spare the added expense of housing them in a dormitory. Only then can physician’s and all of us, earmark increasing amounts from each paycheck to build a comfortable savings cushion.

A New Collaborative Approach

What’s needed is a collaborative approach [much like emerging Health 2.0 participatory medicine], since Financial Advisers cannot be the sole catalyst for change. The media too, needs to do much more reporting on the dangers of debt. Politicians need to make difficult choices [a balanced budget, for example] and business leaders need to be more vigilant about adopting ethical practices when it comes to lending, advertising or marketing products and services that feed the vicious cycle of indebtedness.

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The Courage to Deliver Tough Love

Astute Financial Advisers can take on a real collaborative leadership role with regard to helping doctors and other clients avoid or dig out of debt; but the FAs who have the intestinal fortitude tend to have the most affluent clients. So the question becomes, do they have the courage to deliver tough love to their working or upper-middle class, or affluent middle-class clients and prospects?

The Faithful

For doctors to have faith in their FAs, they need to trust their expertise as a financial health practitioner and believe in the power of a diversified investment portfolio. But, they also need to be repeatedly told to stick with their long-term financial plan whenever there’s a downturn in financial markets and not be swayed by fear or the lure of short-term gain.

Financial Advisers who are willing to recognize and treat the symptoms of irrational decision-making, and educate their physician-clients on the follies of making emotion-based decisions, will be able to distinguish themselves in a competitive market. They need to understand investor psychology, as well as identify behavioral biases and offer counsel about the perils and consequences of irrational decisions. They need to know their target physician market-audience, too. This will enhance the results of their long-term planning.

Rethinking Mission

At the end of the day, it’s not just a matter of offering financial planning. It’s as much about life planning as helping get a client’s financial house in order. Just ask Richard Wagner or George Kinder, who describe the movement they created as “the human side of financial planning” and holds workshops that teach advisers client-relationship skills.

But, an even better objective would be to offer financial health planning as part of a more holistic, and arguably, effective approach.

Avoiding Unscrupulous Lending Practices

The best Financial Advisers know how to steer their clients away from unscrupulous lending practices, resist the urge to over-consume and learn financial discipline; but unfortunately they’re a rare breed. Unless the status quo changes, financial planning runs the risk of irrelevance.

How can people possibly expect to amass adequate savings for a home, child’s education and/or retirement if they can’t first dig out of debt? The only possible result will be legions of unhappy clients.

NPOs?

One way to help combat the nation’s difficulty in dealing with debt would be through the creation of a quasi-governmental, nonprofit organization whose educational mission is to better understand the basic issues surrounding the need to borrow money.

But, perhaps the time has come for the some 200 educational institutions that teach financial planning to pool their resources in hopes of becoming a credible watchdog of the nation’s financial health.

Lawmakers increasingly have come to the realization that financial literacy needs to become a higher priority. Advisers should never forget that sound financial health is a necessary condition for good physical and mental health, especially since most married couples argue about money more than anything else and financial distress is a leading cause of depression.

Link: http://www.fa-mag.com/issues.php?id_content=2&idArticle=1640#

Assessment

In the future, Financial Advisers could serve as financial health practitioners in partnership with counselors, behavioralists and psychologists. The very health of financial planning just might depend upon it.

Somnath Basu, Ph.D., is program director of the California Institute of Finance in the School of Business at California Lutheran University where he’s also a professor of finance. He can be reached at (805) 493 3980 or basu@callutheran.edu.

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Predicting the Economic Recovery

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How Would Life Change – Even if Prescience Possible?

By Somnath Basu PhD, MBA [www.clunet.edu/cif]

All medical professionals and ME-P readers should know that there’s about a 50% chance that someone will predict correctly when and how the domestic economy will recover. The chances of that person failing are the same, at 50%. There is very little chance (probability approaching zero) that nothing will change. Under these circumstances, it’s quite easy for the pundits to take a shot at being right. It is easy to be wrong because it’ll never be held against them, given the circumstances around the global financial crisis. There’s always a way out of being wrong.

Of Rumors, Guesses, Optimism and Pessimism

Of course being right has its rewards of reaping benefits without any downside. In the meantime, a whole nation is being held hostage as to what happens next. Rumors, guesses, optimism, pessimism abound as stock markets rise and fall, employment goes down by less or more than expected, price of oil suddenly becomes a leading economic indicator, China starts showing the way out, interest rates remain low, home (new, used, new construction, commercial vs. residential) sales increase and decrease in tandem, inflation is a problem but not deflation or vice versa and the economy grows as expected or not. The bewilderment at this state of things is taking a toll but the pundits keep going on. Politicians scream and bureaucrats moan. Obviously, this too is a crisis of sorts.

The Two Questions

There are two questions that fall out of this scenario. First, how does one predict the economy and how sound are the methodologies. Second, and more importantly, do we really need a prediction? I will explore these questions in the order presented above but the first one in more detail.

Let’s Begin the Evaluation

To begin with, it’s useful to evaluate the techniques used by our economic gurus who preach lofty sermons from their altars. These folks have a battalion of charts and graphs depicting why something is happening, ably backed up by rigorous mathematical models that have passed the test of their enlightened peers. These people consider economic indicators using complex models of GDP growth, change in unemployment, trade imbalances, flow of goods and services etc. etc. At the end of the day, they still have a 50% chance of being right. Of course they have a theory already explain this possibility (efficient market hypothesis, or EMH) which they use to explain why the market cannot be predicted with any certainty and the odds of predicting correctly are as good as repeatedly calling a coin toss right. However, it seems that this does not dampen their need in any way to keep on predicting.

 

 The Comparisons

Compared to previous recessions, there is a marked difference with the one we just experienced. This difference is that the great recession of 2008-09 can be considered as the first true global recession where even remote countries in Africa experienced mild recessionary conditions.

Hence, one of the first requirements for the predicting community is to truly incorporate global economic conditions in predicting the future. The current emphasis on domestic economic conditions precludes to an extent our ability to comprehend the changes underlying this “one world” which is necessary to get closer to a more realistic prediction. Further, we should include not only the developed economies along with some of the major emerging markets, but literally all economies, in extending our analysis. As we will ponder later, our model for prediction should be much more inclusive of all countries, no matter how small or economically less developed the countries are.  The understanding here is that given the fragile nature of the global economy at present, even a small non-economic ripple in a distant land can turn into something that encompasses the globe in some kind of economic turmoil.

Thus, hopefully, a globally inclusive model of understanding should definitely help us in the business of prediction.

Departure from the Traditional View

At this point I am going to depart from the traditional view that predicting the future of any economy should necessarily be an exclusive economic model. I shall argue that in this world we live in, such a model is inadequate if we realistically expect to beat the odds of a coin toss game. The point I seek to make is that in a world where we are so dependent of each other, how can we exclude factors like political or social conditions, geographic dispositions and historical interrelations, religion, world health, poverty or global climate change. I am going to elaborate upon some of these above contentions with some simple examples to support my view of an all inclusive understanding model before we go about the business of predicting the economy.

War- What is it Good For?

Consider the politics of wars in the world. Does it have an impact on our economy? It sure does. If we are directly involved, it has a huge cost in human suffering besides the direct dollar cost of war. The countries we are engaged in are similarly impacted by their casualties in human lives (and the subsequent economic effect of that) and the real time dollar costs of the real and financial economy being in shambles. If our country is not directly involved in some war overseas, then the whole defense and allied industries stands to gain – we are by far the largest suppliers of weapons in the world. Hence any war has economic consequences from tangible dollar costs to the associated costs of low morale, drops in consumer confidence, etc. An even simpler example would be to look at the wars we are engaged in (in Iraq and Afghanistan) and ask ourselves whether the economic consequences are not sufficient enough to be included in a predictive model.

Global Climate Change

What about global climate change? It is far too late to say it is not real. The main question is whether the economic consequences of global climate change are large enough to be included in any predictive model. What is the impact of climate change on our economy from the increased ravages of floods,   and famines? Costs in crop loss, insurance claims, higher food prices etc. etc. are surely not trivial. Are we willing to say that in the future these extremes of weather will dissipate and not increase so that we do not need to consider their economic impacts? If the climate changes problem is real then we do need to do something about carbon emissions and fossil fuels even as we find larger and larger oil deposits.

However, it is not enough for us to move strongly in this direction. China and India are already crying foul as the world tries to persuade these two countries to slow down carbon emissions. It is a difficult pitch to sell since the retort is that the economic development in the western world is what caused this condition and it is unfair to ask these two countries to slow down their growth ambitions especially since they have waited so long to wait their turn.

Moreover, less consumption of commodities (e.g. of oil, steel, building material) by China and India will trigger economic events of their own since lower production levels in these countries would mean higher costs to us since we are the main consumers of their economic production. The irony of this argument is that if these countries are not halted from their frenetic economic activity and stepped up consumption of commodities, then there is a good chance of inflation creeping through the commodity sector.

However, the point to make is that the effects of global climate change certainly do have serious economic consequences and excluding it would surely denigrate the prediction.

Other Issues

There are other associate issues. What is the impact of global poverty on future economic activities? Should this be an issue at all? What we don’t observe is the staggering scope of this problem. Let me clarify with a simple example. There are roughly 1.2 billion people in India. Another rough estimate would be to state that about 5% of this population are millionaires (in dollar terms), especially when you factor in that for each Indian Rupee that is accounted for (in the economic system) there is at least two Indian Rupees that are unaccounted (money on which tax has not been paid and has not been laundered either (black money) for but that which circulates in the economy.

Another way of expressing the 5% is to say that there are more millionaires (60 million) in India than there are people in France!! Another 400 million can be considered the middle class. No wonder India is an attractive market to developed nations whose internal markets have become tepid.  However, this also means that the rest of the Indians (about 750 million) live in abject poverty, on a dollar a day. Given that this is an average consumption value, there ought to be about 350 million Indians who live on a lot less than $1 a day. And, this entire population is growing.  In China as in Indonesia; in Bangladesh and in Nigeria. In Brazil and Russia. A growing number of people who are hungry and clamoring for food. People who are adding to the others in claiming land to live on, away from agricultural production. Is there a limit of how many people the world can support before it breaks apart. Does this have any significant (other than the usual Malthusian one) economic impact? It does for sure; much more surely than climate change and swine flu. Yet our models and predictions are oblivious to these possibilities.

SAARS

Physicians and ME-P readers may recalls that about 5-6 years ago, we saw the advent of SAARS, a lethal infection in China and Taiwan, beginning to spread in other parts of the world. There was an immediate and sharp economic impact on many of the industrialized nations. Fortunately for us, the spread of the infection was arrested and the global economy quickly got back in track. Surely, we were lucky. A few years ago, the world witnessed bird flu, an even more lethal viral infection. This too was quickly contained. At some point during the financial meltdown of 2008-09 we witnessed the advent of swine flu, a close relative of the bird flu. This time too we were lucky.

Of course, it is important to note that these infections are one step away from being an epidemic of immense proportions where 100s of millions may perish. If the swine flu was not contained when it appeared in late 2008 – early 2009, the financial meltdown we experienced would seem like a tame event. What happens if the next time and next viral mutation around) we are not that lucky? Should we consider the economic consequence of such an event, albeit within a probability framework?

Non-Economic Issues

As we can see, there are many other noteworthy non-economic issues that can have serious economic impacts.  As a matter of fact, we can all conjure up other examples of non-economic issues at will and make a case for their inclusion because we can so easily rationalize their economic impact. But I have made the point to wrap up the answer to my first question – how good are the economic models? Not much, really.

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Educated ME-P Readers

Since my readers possess financial knowledge and acumen, it is worthwhile for me to allude to the various predictions that are flying about in the economy without having to explain them in great detail. This time around, predictions of economic recovery are in the form of shapes. So now the big question is whether the recovery will look like the shape of a V (a sharp recovery) as compared to a U (a prolonged recession followed by a fairly sharp recovery) or a W (a second round of recession followed by another sharp recovery or like a pair of conjoint Vs (V V). The latest one I had the misfortune to hear about was a square root (√, a V-shaped recovery till a point after which the economy changes very little for a considerable period of time). What is also quite obvious that we can make up many other shapes like the above, using economic (and non-economic) arguments as mentioned earlier but at the end of the day, any one of them has a 50% chance of being right. Because our theories say (yes, the very ones we constructed) that markets are efficient and predictions are futile.

Which brings us to the second question: knowing all this, how important are predictions in the way we live. How much better would our lives be, knowing that one or two of these predictions are right and all others are not? Can we identify the ones that are right?  Most likely not, and definitely much harder than finding good or bad stocks.

Assessment

How would our lives change if we could find that handful of people who predicted correctly and consistently more often than not, if there were such people? Surely, armed with this knowledge, we would be able to exploit the predictions for gain. But, given the odds, it is also quite plain and obvious that finding such people is as difficult as winning the lottery. We know the odds. We continue to admonish our clients who stray in these extreme speculative peripheries. Yet, when it comes to reading about predictions, we continue to play the lottery, in hopes of a windfall. The windfall wills make us richer, but will it make us better or happier?

Note: Dr. Somnath Basu is a professor of Finance at California Lutheran University and the President of Financial Health Technology (www.financialhealthtechnology.com), a personal financial software company.

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Understanding Financial Tolerance in the New Era

[By Staff Reporters]

Some physicians and financial planners prefer to use a specific approach in determining these difficult-to-determine areas, in lieu of one of several psychological tests that are currently available.

Examples of this specific approach follow.

Investment Temperament

Which statement best describes your investment temperament? Please indicate by ranking the items below from 1 to 4, with 1 being the most descriptive and 4 being the least descriptive. Also, please indicate the extent of your risk aversion by indicating what percentage of your assets you would feel comfortable investing in each category (for example, 50% in the first category, 25% in the second, etc.).

 

Numerical   Percentage  
ranking   allocation  
* I prefer only the safest of investments.
* I am interested only in “blue-chip” investments.
* An occasional risk is worth the effort for above-average potential reward.
* I’m willing to put everything on the line if the potential reward is large enough.

Listed below are various forms of investments. Please indicate your familiarity with each.

  Familiarity
Description High   Low
Certificates of deposit 5 4 3 2 1
Treasury bills 5 4 3 2 1
Other short-term fixed income 5 4 3 2 1
Stocks 5 4 3 2 1
U.S. government bonds 5 4 3 2 1
Corporate bonds 5 4 3 2 1
Municipal bonds 5 4 3 2 1
Mutual funds 5 4 3 2 1
Real estate—direct ownership 5 4 3 2 1
Real estate—limited partnerships 5 4 3 2 1
Oil and gas 5 4 3 2 1
Collectibles 5 4 3 2 1
Precious metals 5 4 3 2 1
Insurance products 5 4 3 2 1

Assessment

Any other thoughts on behavioral finance topics, like this?

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