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In our recurring theme of looking at the irrational side of human beings and ways to combat our poor decisions, we think some examples might be useful. Michael Mauboussin, the Chief Investment Strategist at Legg Mason Capital Management has a new book, Think Twice, which gives us some instructive examples.

Famously, developmental psychologist, Stephen Greenspan, published The Annals of Gullibility, the first comprehensive academic treatment of why people are gullible.

Almost immediately after its publishing in December of 2008,  Bernie Madoff’s Ponzi scheme hit the news.

Ironically, Greenspan had a third of his retirement assets invested with Madoff.

Greenspan, who certainly should have known better, suffered from what is called superiority bias. He assumed he wasn’t as susceptible to the flaws he chronicled than the rest of us. We all suffer from this in one way or another. 80% of us believe we are better-than-average drivers.

Let us combine that with the anchoring and recency bias. Mauboussin relates the story of asking some students at Columbia University to write down the last four digits of their phone number. After doing so, he asked them to estimate how many doctors there were in Manhattan. Unsurprisingly he found that those with lower phone numbers estimated fewer doctors than those with higher phone numbers.

We tend to anchor to whatever information we have most recently been exposed to, regardless of its relevancy. We see this in investing when even experts decide the value of a stock or other asset is most appropriately based on what its recent price has been. Stocks are cheaper than they were, so they must be cheap. Never mind that they are basing their sense of value on the most expensive period for stocks in history. There are numerous examples of such biases and irrational beliefs.

 

This is one of my favorite presentations from one of my favorite sites, TED.com.

What is TED?

"TED is a small nonprofit devoted to Ideas Worth Spreading. It started out (in 1984) as a conference bringing together people from three worlds: Technology, Entertainment, Design. Since then its scope has become ever broader. Along with the annual TED Conference in Long Beach, California, and the TEDGlobal conference in Oxford UK, TED includes the award-winning TEDTalks video site, the Open Translation Program, the new TEDx community program, this year's TEDIndia Conference and the annual TED Prize."

The number of incredible and fascinating ideas you can watch and listen to while at TED is simply astounding. Watch this before you wander over there. Presented in 2006, Hans Rosling takes you on a wonderous journey into the world of interactive visual data and how it can reveal things in ways that the raw data itself cannot. If you ever thought statistics was boring, this will change your mind. The subject is the developing World.

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He has since given us yet another view on the data. Rated at TED as draw dropping, I haven't watched it yet. You should probably beat me to it.

 

 

 

 

(For printable pdf version click here)

Recommended reading

 

I am in the midst of a fascinating book, covering a little known chapter of our history, THE RIVER OF DOUBT.

From Publishers Weekly

"In a gripping account, Millard focuses on an episode in Teddy Roosevelt's search for adventure that nearly came to a disastrous end. A year after Roosevelt lost a third-party bid for the White House in 1912, he decided to chase away his blues by accepting an invitation for a South American trip that quickly evolved into an ill-prepared journey down an unexplored tributary of the Amazon known as the River of Doubt. The small group, including T.R.'s son Kermit, was hampered by the failure to pack enough supplies and the absence of canoes sturdy enough for the river's rapids. An injury Roosevelt sustained became infected with flesh-eating bacteria and left the ex-president so weak that, at his lowest moment, he told Kermit to leave him to die in the rainforest. Millard, a former staff writer for National Geographic, nails the suspense element of this story perfectly, but equally important to her success is the marvelous amount of detail she provides on the wildlife that Roosevelt and his fellow explorers encountered on their journey, as well as the cannibalistic indigenous tribe that stalked them much of the way."

If you love history, adventure novels, or just fine writing, this book will fit the bill.

 

Whackabanker: The Brits are really upset

Britains next big video game hit. I don't mean to be unfair, as many a community bank here in Louisiana has been quite responsible. Investment bankers? Not so much. However, a model with Ken Lewis, John Thain, Stanley O'Neal and a few others might just draw my interest:

You can see the video by clicking here.

 

 

Whereupon we duly admit to having a major conflict of interest

The news has been filled with debates over financial services reform. We, and much of the advisory profession, believe that providers of advice, as opposed to a product salesperson, should be required to act in their client’s best interest (to be a fiduciary in legal parlance.) In what can only be described as unsurprising, the big investment brokerage houses and insurance companies have beaten that argument back.

That should bother you, but we will take it in stride here at Thompson Creek. While the American public deserves better, we think it is in our best interest that the industry keep on going down the path they have chosen, which is to only require of themselves that what they suggest you buy is not “unsuitable.”

Given our representatives inability to end the practice of salespeople masquerading as advisors we will give you some free advice. The next time you hear from a purveyor of financial advice, we suggest that you ask them to sign a pledge, and agree to it contractually, where they state:

  1. I will always put the client's best interest first — ahead of my own and that of my firm and its employees. As defined by federal law, I will act as a fiduciary.
  2. When selecting investments, I will act as the client's agent, seeking the best investments for you at favorable prices at all times.
  3. While neither I, nor anyone, can promise superior investment returns, I will provide impartial advice and act with skill, care, diligence and good judgment.
  4. I will provide full and fair disclosure of all-important facts, including my compensation from the providers of the products and services I offer, as well as all fees I pay to others on your behalf.
  5. I will fully disclose and fairly manage, in the client's favor, unavoidable conflicts.

That includes us. In fact, from now on, it will be part of our contract. Hmmmm….. Reading number 5 it seems we have to disclose a conflict of interest already. We find it amusing to point it out, but it is most definitely a conflict of interest for us to suggest you only do business with advisors who will legally bind themselves to put your interests first.

 

So, your advice was just an adjunct?

From Harold Evensky:

"David A Genelly, an attorney representing brokerage firms said, “Extending the investment adviser’s full-blown fiduciary duty to brokers acting in non discretionary accounts – i.e. merely those who “recommend” purchases – is fraught with so much potential mischief that it undoubtedly has the plaintiff’s securities bar rubbing their already sweaty palm together with glee over prospects. A broker is a broker, and an adviser is an adviser. If brokers are now going to have the same fiduciary duties that advisers have, simply because they render some adjunct investment advice when we make recommendations, there is no telling where the liability will stop [my emphasis].” I guess if you ever receive “adjunct” investment advice you’d better take it with a grain of salt, or, better yet, maybe you should run for the exit."

At least you should ask whether the advice was adjunct or not. Maybe that is all you need and you understand you are dealing with a broker (a salesman.) If you were under the impression you were getting advice that was not merely an adjunct, then please run for the exit. As Genelly says, a broker is a broker and an advisor is an advisor. They shouldn’t be confused. I just suspect he doesn’t want them confused in court. He is all in favor of his firms not pointing out to the consumer that they are different. There they want them to be confused.

Don’t blame the individual brokers themselves. Many want to not merely act as fiduciaries, but truly be fiduciaries. They are not allowed to do so.

 

 

 

 

 

 

 

 

 

My comments on a dustup between two interesting fellows in our industry were just published in Advisor Perspectives, a very popular web magazine for advisors. While what we are discussing is a bit "under the hood" and filled with inside industry concerns, if you are interested, feel free to read my opinion at the site.

To make the story short, Roger Schreiner runs a very successful active trading advisory service, and challenged advisors who manage their assets passively, with strategic asset allocations (often index funds or ETF's) to a contest (with money on the line) to see who would be more successful over time. Dave Loeper, another successful and influential advisor accused Roger of setting up a rigged game while explaining why he felt active investing is inherently more risky. The argument was on.

As for myself, I think the active versus passive debate is misplaced, and both approaches have a place in an advisors toolkit. However, I thought Mr. Loeper's argument was not very strong, and inappropriate to the contest. As I said, not something everybody will have an interest in, but it is not too filled with industry jargon and my argument is made in a conversational manner. You can read it here.

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