Weekend Reading for Financial Advisers: Prospect Theory, Pressure, and Premiums

This week’s selection of interesting reading (and viewing) from the past few weeks, presented in no particular order:

Behavioral Finance

• Have you ever wondered what you will look like in 10, 20, or even 30 years? Apparently seeing our future selves (something we are not apt to do; hello “present bias”) can affect financial decisions, including saving for retirement. In this TED talk from 2011, Daniel Goldstein examines the ongoing battle between our present and future selves. He displays a great quote from Nassau William Senior, the 19th century English economist, to explain why this is so difficult: “To abstain from the enjoyment which is in our power, or to seek distant rather than immediate results, are among the most painful exertions of the human will.” (TED)
• For more on “present bias” and our future selves, see Cass R. Sunstein’s piece from October 2012: “Stay Alive: Imagine Yourself Decades From Now.” (Bloomberg)
• “The Psychology of Human Misjudgment” — Charlie Munger’s famous 1995 talk in its entirety. Need I say more? (Farnam Street)
• “Thirty Years of Prospect Theory in Economics: A Review and Assessment.” (Journal of Economic Perspectives)

Investing/Risk Management

• Bob Seawright has put together a list of what he calls 10 “investment default settings.” It’s a handy cheat sheet for the next time you review the investment process with your clients. (Above the Market)
• In a recent column, Jason Zweig points out that the past decade has shown that traditional diversification “can leave investors exposed to the risk of severe losses.” What investors should do, instead, is think about diversification in a different light — what he calls “differsification.” He writes: “Instead of spreading your bets to protect against a plunge in the U.S. stock market, you should regard your portfolio as a set of bets on basic economic conditions and create one bucket for each: expansion, recession, inflation and deflation.” (WSJ) Note: Zweig is speaking at an upcoming conference in Charlottesville, VA: Behavioral Finance: From Theory to Practice, 7–10 April 2013.
• I recently discovered Chris Arnade’s articles and have become a fan. Chris has a PhD in physics and started his career on Wall Street building credit models before moving on to trading options, bonds, credit derivatives, interest rates, and foreign exchange. Now he focuses on photography. But, from time to time, he pens blogs for Scientific American. Here’s one to get you started: “Too Big to Succeed.”
• Have you seen Zero Dark Thirty, about the hunt for Osama bin Laden (or UBL as he is often referred to in the film)? If so, this piece on Zero Dark Thirty and Bayes’ theorem may pique your interest. (Statistical Modeling, Causal Inference, and Social Science)

Insurance/Elder Care

• In “Gender-Based Pricing Coming Soon To Long-Term Care (LTC) Insurance,” Michael Kitces writes about an important change coming into effect for long-term care (LTC) insurance: Women who apply for coverage individually could soon face higher premiums. (Nerd’s Eye View)

China/Economics

• As my colleague Ron Rimkus, director of economics, pointed out in a tweet, Michael Pettis’s latest newsletter “delivers a tour de force of economic history — draws lesson for China.” See: “Pettis: China and the History of US Growth Models.” (via Naked Capitalism)

Leadership/Stress Management

• Why do some people succeed under pressure while others fail? It is a question that has been tackled countless time in recent years, including a 2010 book aptly titled “Clutch: Why Some People Excel Under Pressure and Others Don’t.” More recently, however, the question was explored through the lens of children and exam stress: “Why Can Some Kids Handle Pressure While Others Fall Apart?” As I learned, we all carry the COMT gene, which “carries the assembly code for an enzyme that clears dopamine from the prefrontal cortex. That part of the brain is where we plan, make decisions, anticipate future consequences and resolve conflicts.” There are two versions of the gene: One builds enzymes that slowly remove dopamine while the other builds enzymes that rapidly clear dopamine. We all have one or the other, or a combination of the two, and this plays a big role in how we handle stress. The article is a great read and doesn’t just apply to children and parents — we can all learn more about why we respond to stress the way we do. (The New York Times Magazine)

And Now for Something Completely Different

• Oliver Sacks, neurologist, writer, and amateur chemist (a.k.a. professor of neurology and psychiatry at Columbia University), published a fascinating essay on memory: “Speak, Memory.” Spend time with it, it’s worth it. (New York Review of Books)

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/JLGutierrez