High Five for Love!

Often the quote, “Better to have loved and lost than never to have loved at all” is used around this time of year, but is the same true for investments? Is it better to have invested and lost than to never have invested at all?

Clearly, in monetary terms, the answer is simple - no. Underneath this there are some other underlying factors. By having invested any money at all, a person is gaining a new experience that they can learn something from. Now I’m not saying, that this very yoctosecond you go out and invest your life savings, rather people should consider investments as a quintessential part of anyone’s retirement plan.

Too many people don’t understand their opportunity costs, costs of capital, and risk tolerances. People say they are risk-averse, but when the market is booming, they no longer care to hedge and diversify risks. Eventually the bubble pops and there’s a landslide. People may come to see their mistakes, but somehow they forget and the vicious cycle continues. This increases market volatility and should be discouraged.

In Behavioral Finance, Daniel Kahneman and Amos Tversky developed Prospect Theory. One of the key takeaways of this theory is that people get more disutility through losses than utility through gains. This plays a very important role in downside protection of wealth and gives a reason to why value has outperformed growth for extended periods of time.

As seen in the graph, as your losses increase linearly, your gains needed to recover to zero increases exponentially. “Extra needed” shows the difference between “what is needed to make up” and the “loss.” “Marginal increase of need to make up” is the increase of what is needed to make up as losses increase.

This ties in with Prospect theory because people in reality don’t want to lose money, not really because of the snowball effects, but more because they are losing hard-earned money that is hard to get back.

The thing is, hard-earned money, should be used for intensely researched investments. People shouldn’t invest just so that they can “get rich quick,” but rather because they love finance and investments, what it means to learn more about a company, the economy, and human psychology. The returns are a bonus to continue what you are doing. This is why I believe in that passion and prestige in not just Finansophy, but in anything that you are interested in and passionate about. Warren Buffett says, “you should do the job you love whether or not you are getting paid for it. Do the job you love. Know that the money will follow…. If you’re doing something you love, you’re more likely to put your all into it, and that generally equates to making money.” Perhaps this is the meaning of life that everyone’s intrinsically searching for.

(Image CC-BY-SA *Zara.)

Super Bowl, Twosday, and Beyond

With Super Duper Tuesday probably the most important thing happening this week (sorry football fans), I thought it’d be timely to provide some information.

We are in trying times this year, with housing, recession, credit worries, elections, etc., which is why there has been so much volatility in the markets. People are uncertain what will happen. To mitigate some of that risk, everyone should be going out to vote when it is their state’s turn. Before voting, of course, you should layout all the options, and I don’t mean just Democratic and Republican.

In my humble opinion, I think the US’s political system is very flawed. There are two major parties, people don’t do their research, people don’t vote, and the voting system isn’t optimal.

Many people think that there are just Democrats and Republicans when there are many other parties and other people. It’s not all the people’s fault, the media highlights the extremes and the two largest parties because they are perceived as more important, and they’ll get better ratings. This continues the cycle. Don’t get me wrong, I think the media is very important, in fact, just me writing this “rant” is part of journalism. Journalism, along with Education, Healthcare (?), and of course Finansophy are among the most influential and important careers anyone can be in.

People don’t really take the time to look into a candidate and everything they believe in. They are deciding on The Commander-in-Chief of the USA, they should do some more research. Maybe that majority of people that aren’t voting are all in protest against the system, but not voting doesn’t help. You allow a minority of people to control the majority when you don’t vote.

How’s this relate to Finansophy? By taking part in our voting system, you have a say on what will happen, thus giving your projections some more accuracy and thus less uncertainty. You’ll also be able to capture what people are thinking about, what affects them, what plans the future leader may pursue. This should allow you to make better judgments on what will happen in the future with less risk, and thus higher risk-adjusted returns. The President, believe it or not, has a lot of say into what’s going to happen to the economy and its people, as seen by Bush’s recent economic stimulus plan. They also bring with them all their supporters, whether it be their Cabinet, or Justices. Each of the candidates have a different moral philosophy that they use to judge what is right and wrong for people in the US. Not voting is essentially giving up your right to complain if anything you don’t like happens. It also perpetuates the vicious cycle and doesn’t solve the problem. At the minimum, you should protest vote (and vote for a political philosopher?) to show that people are listening and not liking what is happening.

There are also many superior voting systems out there than our electoral college. Read up on them and try to promote them so that we have a fairer system that everyone may be more willing to participate in.

In Plato’s Republic, Philosopher-Kings were the ideal rulers of everyone because they knew what was fundamentally Good and thus all their actions were maximally just for everyone. Now go out there and look for a Philosopher-King!

(Image CC-BY-SA telethon.)