Blame the Models? Take a Good Look in the Mirror

Is financial modeling to blame for the recent crisis? As always the fault does not lie with the tool but rather with the user. When was the last time you took a look at the validity of Net Present Value or Option Pricing?

The recent, or ongoing, financial crisis has been attributed, amongst other things, to over reliance on quantitative financial models which replaced good business judgment instead of supporting it.

The reason behind the failure of models wasn't simply poor modeling, for the most part. The main reason was poor business and risk management processes which placed blind faith in the models.

In this post I begin to explore the reasons why financial modeling increased the severity of the recent crisis and more importantly, what are the lessons we can implement to our personal finances?

The need for Financial Modeling

With the development of computing power advanced mathematical models enabled the creation of complex new financial instruments and professions such as financial engineering. Mathematicians and statisticians found their way to investment banks and hedge funds due to the increased demand and profitability of these endeavors.

These financial instruments included, for the most part, new underlying assets, that require complex financial models to model their pricing and behavior. Financial models which sadly broke during the recent crisis.

That is not to say that financial engineering and the use of models have been proven unsuitable for the financial markets. Much on the contrary, financial engineering and complex financial instruments help, in many cases, to increase the level of perfection in the market and ease the transfer of undesirable risks from one party to the other.

Models as a Representation of Reality

A Model, by its definition, is a representation of reality. Economics, for example, as any 1^st year student knows is based on very simple models of production, supply, demand and price. The strength and importance of these models is their ability to explain economic behavior even under very simplistic assumptions.

Think of the prisoner's dilemma in game theory or Nash's equilibrium which are very simple models that won their authors Noble Prizes. The beauty of the model is its ability to represent reality with a very limited framework.

As modeling advances assumptions are slowly removed creating more and more complex models which require a better understanding of the mathematic complexity. The reason is simple, the more "free" parameters the model needs to explain the higher the complexity.

Naturally, when dealing with financial instruments and their fair value pricing, models need to explain as much of the price as possible to adequately represent the fair value of the instrument. As such, models have grown quite complex as room for assumptions is very small.

What went wrong?

Before we get too judgmental let's consider the simple, commonly used model of Net Present Value. Net present value is a model used to determine how much a certain stream of cash flows is worth today – or, the present value of the cash flow.

Net Present Value is commonly used to determine the economic sense behind undertaking certain projects and investments. All those in the finance profession, as well as personal finance enthusiasts have probably tried to determine the net present value of a certain undertaking. The problem starts when you dig deeper into the model.

Most people are not aware Net Present Value assumes the following due to the very central role of the cost of capital in the model (further reading on NPV is available here):

• The existence of an efficient financial market – In order to price correctly an efficient financial market is required. NPV cannot be turned into value in the present if an IPO cannot be performed or valuated correctly.
  
  
• Access to financial markets– Without access to an efficient financial market the entrepreneur, again, cannot transform NPV to value in the present.
  
  
• The existence of diversified investors – Adequate pricing of the cost of capital can only be performed by ignoring the specific risk of the investment. A diversified investor, in finance, sees only the market risk when investing (the reason being a diversified portfolio will stay diversified even after investing in this particular project, for example).

When was the last time the Net Present Value calculation you had performed met these requirements? My guess is never.

The model is a helpful tool but the underlying assumptions and limitation cannot be ignored.

The reason behind why many of the financial models broke has to do with the assumption of liquidity and volume in the markets. Pricing models are built to price instruments under a normal market environment, as part of the normal course of business. When stressed scenarios occur the assumptions behind the models cease to exist and the model breaks.

• Black and Scholes model very commonly used for option pricing assumes normal distribution of returns (Not true, obviously).
  
  
• The CAPM Model (Capital asset pricing) which is a corner stone in asset allocation is based, again, on normal distribution of returns but also assumes, amongst others, the following highly debatable assumptions: Perfect availability of information, No taxes or transaction costs and a market portfolio which includes all types of assets (!).

With no liquidity in the markets strange phenomenon start to take place, phenomenon which cannot be analyzed through modeling but rather through good judgment and independent thinking.

The Importance of an Adequate Process

The role of an adequate risk management process cannot be overstated. Financial modeling is a tool, nothing more (and nothing less).

Like any tool the one who uses it needs to understand its capabilities and its limitations. Model limitations are inherent as they are, and only can be, a representation of reality.

Financial modeling will not go away. The need is too strong. What does need to happen is the implementation of robust risk management processes which will continue to remind what are the assumptions and limitation of the models and what the proposed mitigations against these limitations are.

The wisdom of the ancient Greek philosopher Socrates is a fitting quote: "I know that I know nothing" he said, not because he knew nothing because he didn't claim perfect knowledge. A humble state of mind is a very good start.

Related Posts:

• Is Present Value - Value in the Present? The Economic sense behind Net Present Value
• Diversification is Dead. Long live Diversification
• What is the Recommended Investment Strategy for Household Investors?
• Capitalism with Social Equality: A Powerful Though Experiment Demonstrates Our Moral Obligations
• Psychology tricks and increased spending – The Case of Expensive Wines
• The Big Mac Index – Applying Simple Economic Common Sense
• Would You Be Willing To Pay 60% Tax For a Higher Level of Social Equality?

Carnival of Financial Planning - Edition #116 - November 20, 2009

This is a guest post by The Skilled Investor – A great source for Personal Finance, Investment Management, and Financial Planning Articles.

Welcome to the November 20, 2009 Edition #116 of the Carnival of Financial Planning.

The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus on efficient and sustainable personal financial planning practices that can lead to lifetime financial security.

This edition is arranged by subject heading, so that you can browse efficiently.

Enjoy!

Featured

I do not normally feature any submissions. However, this one, which was submitted to the Miscellaneous category, deserves to be featured. The title alone warrants that accolade:

Sustainable Life Blog presents The High Cost of Being a Moron posted at Sustainable Life Blog, saying, "Perfect example of how a small mistake can cost you big bucks when selling a car."

Budgeting

Four Pillars presents Get Out Of Debt With YNAB – You Need A Budget Financial Software Review posted at Quest For Four Pillars, saying, "Indepth review of You Need a Budget software."

Susan Saverton presents Personal Budgets posted at Family Financial Planners, saying, "When you don't understand how much you spend and how much you save and invest, you do not have a financial plan. This dramatically increases your family’s long-term financial risk."

Economics

Emily Simmons presents How to Make a Budget That Works posted at Be In Health Now, saying, "A budget is the foundation on which financial freedom is built. Learn the basics here."

Estate Planning

The Financial Blogger presents Estate Planning: 5 Reasons Why You Should Have A Professional Among Your Liquidators posted at The Financial Blogger, saying, "managing an estate is more complicated than simply writing a few checks! Fortunately, for those who can afford it, you can name a professional among your liquidators."

Jeff Rose presents Your Estate Planning Checklist posted at Jeff Rose.

Financial Planning

David Carlson presents Eight Reasons Why Its Hard To Get Rich posted at Dual Income No Kids, saying, "This post describes eight different reasons people do not become rich. When you take these eight reasons into consideration, you can overcome the various roadblocks that prevent people from becoming wealthy."

Roshawn Watson presents Are Wealthy People Dishonest? posted at Watson Inc, saying, "Are the wealthy dishonest? While it is certainly a fair question, it is also a polarizing one. The typical dichotomy is that there are some who feel like there is absolutely no way for honest people to get ahead financially while the wealthy often feel maligned for their prosperity."

James Carter-Truman presents 4 “Must Have” Precious Metals Investment Tips posted at Buy Gold Secrets, saying, "James Carter-Truman is an expert about gold and he writes to share his knowledge about Gold investment"

Susan Saverton presents Financial Advisor Pasadena California posted at Pasadena Financial Planner, saying, "Appropriately setting your personal asset allocation in line with your personal risk tolerance is a critical decision for every investor. The percentages that are allocated to various asset classes tend to change slowly over time, so it is important to get it right at the outset."

Amanda L. Grossman presents The Lazy Person's Guide to Financial Success posted at Frugal Confessions, saying, "This article is all about simplicity and automation in personal finances. Set a plan, automate that plan with specific amounts of time for each step detailed in the article, and leave it! Let compound interest and automatic withdrawals take your finances to the next level."

jim presents Conduct a Financial Fire Drill posted at Blueprint for Financial Prosperity.

Dividend Tree presents Building Core Competency for Long Term Survival posted at Dividend Tree, saying, "whether it is running a business or individuals’ investment portfolio, it is important to build a core competency for long term sustainability. In my case, I focus on good quality companies that consistently pay or have potential to pay growing dividends over time.

Finavigation presents The Right Mindset for Financial Success posted at Finavigation, saying, "For many people, the main thing holding them back from achieving the things they want in life is the way they think. People who are able to build wealth and accomplish the goals they set for themselves continuously think about the world differently than people who are complacent and find themselves stagnant instead of accelerating toward the life they want."

Financing a Home

Joe Manausa, MBA presents How The Cap And Trade Bill Affects Real Estate posted at Tallahassee Real Estate Blog, saying, "I believe that if the American Clean Energy and Security Act of 2009 is enacted, new home construction costs will go up, and home affordability will decline. It appears as if a “national building code” will be created, thus usurping some of the rights of State’s to control building quality as they see fit."

Evolution Of Wealth presents Return On Equity Is Always Zero posted at Evolution of Wealth, saying, "Do you ever wonder what the return on your home equity is? Not your house but the equity that everyone tells you to build up. Well it's zero."

Roshawn Watson presents Should You Buy A House Outright? posted at Watson Inc, saying, "Suppose you find yourself in the somewhat unique predicament of having the resources to purchase your house outright without a mortgage. Is it then financially-wise to make the purchase?"

Brandon Laughridge presents 8000 Tax Credit Extended and Expanded posted at Mortgage Loan Place, saying, "Learn what the new tax credit terms mean for you as a first time home buyer or repeat home buyer."

Alex Fotopoulos presents When to Refinance a Mortgage? posted at My Trader's Journal, saying, "Some key points to consider when refinancing your home."

Financing Education

Praveen presents Will Education Follow the Housing Bust? posted at My Simple Trading System, saying, "Tips for students to avoid excessive loans and debt"

Health Care

Patrick @ Cash Money Life presents Open Enrollment Health Insurance Options posted at Cash Money Life, saying, "what you need to know about the common health insurance options available from most employers during the open enrollment season."

Jeff Rose presents What’s the Best Health Savings Plan For You? posted at Jeff Rose.

Patrick @ Military Money presents Open Enrollment Window Open for Some posted at Military Finance Network, saying, "Open enrollment is the only time of the year that many people are able to make changes to their health insurance elections. Make sure you take advantage of this time to select the best health care option for your needs."

Income

Dividend Tree presents Three Companies with Sustainable Dividends posted at Dividend Tree, saying, "Even in soft economic environment, there are companies out there that are continuing to increase dividends for their shareholders. While dividend increase is good, it is more critical to make sure we understand that companies can sustain their dividends."

MoneyNing presents Take Some Time to Make More Money posted at Money Ning, saying, "While savings is important, taking some time to make money is still critical."

nissim ziv presents Informational Interview Questions: Examples| Request for Informational Interview: Tips posted at Job Interview Guide, saying, "Informational interview is not a job interview. The purpose of this meeting is to find out more about jobs and careers rather than getting a job. It is a meeting in which a career seeker asks for advice about a certain career that interests him."

Investing

Jeff Rose presents Good to Know Rules and Limits for the Traditional IRA posted at Jeff Rose, saying, "As good as the Roth is, the Traditional IRA still has its place."

Brian Terry presents Are You Ready To Buy Gold Bars? posted at Buy Gold Secrets.

Darwin presents 2009 Stock Market Returns YTD from Around the World – Shocking! posted at Darwin's Finance, saying, "This comprehensive analysis of global stock market returns shows some emerging markets in triple digits year to date and surprisingly, the US is toward the bottom of the heap even following its meteoric rise from the March lows."

Silicon Valley Blogger presents Scottrade Review: Top Brokerage For Small Investors posted at The Digerati Life, saying, "Reviewing an outstanding online broker. Scottrade is great for new investors."

ABC presents Top Down Investment Approach posted at ABCs of Investing, saying, "An explanation of the "top down" investment method."

Jules Wells presents Best Investment Strategy posted at Financial Planning Software, saying, "Personal investing seems incredibly complex, but the best investment strategy also tends to be a more simple investment strategy."

Zach Scheidt presents Blue Nile Reports Growth posted at ZachStocks, saying, "Blue Nile Inc. (NILE) reported earnings growth in the third quarter. The company is growing market share but the stock is simply overpriced. Watch for a 50% drop in the coming months."

MoneyNing presents How to Get Your Wife to Invest posted at Money Ning, saying, "Talk and discuss. Learn how to get your significant other to invest!"

FMF presents Portfolio Recommendation Beats S&P 500 by 9.4% posted at Free Money Finance, saying, "Suggestions on a market-beating portfolio."

Zach Scheidt presents Blackstone Sees Improving Trends posted at ZachStocks, saying, "The Blackstone Group, LP (BX) reported earnings and the stock is trading sharply higher. The environment is improving for the private equity company as liquidity and risk premiums increase."

Frank Vertin presents Low Cost Index Fund posted at Best Index Fund, saying, "Buying an S&P 500 index fund through an investment counselor can substantially increase your initial purchasing costs and and drive up your annual management expense fees. Unfortunately, the vast majority of individual investors buy mutual funds and ETFs through brokers and investment advisers. Rarely do financial advisors recommend that you buy index funds with low fees. This is because low cost, no load mutual funds do not pay them as well as loaded, high fee mutual funds."

Praveen presents Just Bought Hyatt Hotels (H) posted at My Simple Trading System, saying, "About Hyatt's recent IPO and why its a good stock."

ABC presents More Exciting Facts About Stock Indexes posted at ABCs of Investing, saying, "Some interesting facts about stock indexes."

Super Saver presents Asset Allocation Investing Based on Time posted at My Wealth Builder, saying, "Here's a strategy that diversifies risk by time."

Steve Patterson presents Gold: Don’t Fight the Trend posted at FastSwings.com - Steve Patterson, saying, "Inflation is also a concern for traders who are predicting a rise in consumer costs as the dollar continues to fall."

Manshu presents S&P 500 ETF List posted at OneMint, saying, "A list of ETFs that track the S&P 500."

Dividends4Life presents 4 Stocks With Higher Dividends posted at Dividends Value, saying, "Investing in Dividend Stocks is a long-term strategy. Frequent buying and selling of dividend stocks can significantly increase your expenses and taxes, thus lowering your returns. A growing dividend is a strong indication of a company’s increasing intrinsic value."

Tomas Escent presents Professional Investment Management posted at Nerds on Wall Street, saying, "Think of this book as sort of a Hitchhiker’s Guide to Wired Markets. There are no robots parking cars for six million years, but there are robots trading millions of shares in six milliseconds, so maybe that’s close enough."

ABC presents “Bottoms Up” Investment Method posted at ABCs of Investing, saying, "A short description of "bottom's up" investing style."

April presents The Roth IRA Made Easy posted at Get Rich Slowly, saying, "Starting a Roth IRA is one of the easiest — and best — steps you can take to save for retirement! A great guide on what they are, the rules that govern them, and how you can start one today."

Zach Scheidt presents China Drug Research Company Reports Stellar Earnings posted at ZachStocks, saying, "Wuxi PharmaTech Inc. (WX) reported strong third quarter earnings. The China drug research and manufacturing company is investing heavily to drive future growth and should see significant earnings appreciation."

The Financial Blogger presents The Financial Blogger » Blog Archive » Canadian ETFs That Pays Dividends – Am I in Heaven? posted at The Financial Blogger, saying, "There are a lot of people that love dividends. There are 2 major reasons why so many investors love them. #1 they are usually issued by very stable companies which mean less volatility in a stock portfolio. #2 they pay quarterly income, which is great for revenue seekers."

Mike presents Living in the Fast Lane posted at Minting Pennies - Personal Finance, Investing, and Microfinance, saying, "How adequate planning and preparation can lead to successful investing."

The Skilled Investor presents Investing Strategy posted at Personal Investment Manager, saying, "Investors more easily understand investment costs that are directly measurable, such as fees deducted on investment statements. However, many investors ignore or are unaware of the opportunity costs of their sub-optimal investment behaviors. Opportunity costs are usually much more difficult to measure directly, but these investment costs can be even higher than more visible investment fees."

Tushar Mathur presents Can't Control the Markets? Try controlling the Costs posted at Everything Finance, saying, "As 2008 proved, the financial markets are prone to unpredictable periods of turbulence. That can make investing feel a bit like a roller-coaster ride. The disappointing results that many mutual funds posted in 2008 and at the outset of 2009 may have left you feeling concerned over your financial future. You're not alone."

Dividends4Life presents 9 Dividend Stocks Sending More Cash To Shareholders posted at Dividends Value, saying, "Looking for the perfect dividend stock? In an utopian world, the perfect dividend stock would be one that is both high-yield and provide a high dividend growth rate. Its share price would appreciate with its increasing dividend. All of this would be driven by increasing earnings and cash flow."

Larry Russell presents NoLoad Mutual Funds posted at Best No Load Mutual Funds, saying, "Taken as a whole, the vast body of investment research studies show that there really are better approaches to buying and owning mutual funds and ETFs. You do not need to frantically chase fund performance. Performance chasing simply does not work."

Steve Alexander presents Magic Formula Stocks in Forbes Top 200 Small Companies 2009 posted at MagicDiligence - Optimizing Joel Greenblatts Value Stock Strategy, saying, "Every year, Forbes creates a list of the top 200 best small companies in America. Which current Magic Formula stocks are part of the list, and which ones have been a part of MFI in 2009?"

Managing Debt

The Smarter Wallet presents Use Secured Credit Cards To Develop Your Credit History posted at The Smarter Wallet, saying, "On using secured credit cards to establish credit history."

Miscellaneous

Tom @ Canadian Finance Blog presents Do You Know If You Are Owed Money From A Bankruptcy? | The Canadian Finance Blog posted at The Canadian Finance Blog, saying, "To help you find out if you are owed money from bankrupt debtors, the Office of the Superintendent of Bankruptcy maintains an Unclaimed Funds Database."

Peak Personal Finance presents 5 Financial Rules for Women posted at Peak Personal Finance, saying, "Good advice for women, and men too!"

Tom @ Canadian Finance Blog presents Do You Know If You Are Owed Money From A Bankruptcy? | The Canadian Finance Blog posted at The Canadian Finance Blog, saying, "To help you find out if you are owed money from bankrupt debtors, the Office of the Superintendent of Bankruptcy maintains an Unclaimed Funds Database."

Dorian Wales presents A Temple Restaurant and a Clearing House for Tickets – Two Observations of New York City posted at The Personal Financier, saying, "New York City is my favorite destination in the world. Any opportunity to visit again, whether on business or pleasure is a joy. With each visit a new light is shed on some other aspect of the city. I'd like to share two such spotlights with you." (Editor's note: Dorian is right about Peter Luger. Best steakhouse around.)

FMF presents How to Buy a New Furnace and Air Conditioner posted at Free Money Finance, saying, "Keys steps to buying a great furnace and AC unit at a great price."

Frank Knight presents Identity Theft Prevention posted at Personal Financial Planning Software, saying, "Financial Planning and Identity Theft Prevention -- Identity theft prevention is a key, but often overlooked, component of a prudent financial plan."

No Load Bond Funds presents Low Cost Bond Funds posted at Bond Index Fund, saying, "Simply put, if you pay higher bond mutual fund fees, then these bond management expenses tend just to be a deadweight loss to you. The best bond fund buying strategy is to pick only very low-cost no load bond funds."

Patrick @ Cash Money Life presents Netflix Review - Online DVD Rentals posted at Cash Money Life, saying, "Netflix is a great way to save money on movie rentals, especially with the $8.99 unlimited plan that comes with unlimited DVD rentals and unlimited video streaming. Check it out with a free trial if you've never used it."

Susan Saverton presents Personal Financial Strategy posted at Family Financial Planner, saying, "When pursuing optimal financial planning and investing strategies and controlling your costs and capital gains taxes, you also need to establish a time-efficient system to monitor, adjust, and adhere to your financial plan."

Retirement Planning

FMF presents The World's Best Places to Retire posted at Free Money Finance, saying, "One way to make your retirement savings go farther is to retire overseas."

Top Stock Index Mutual Funds presents Stock Index Funds posted at Top 10 Index Fund, saying, "To build your retirement portfolio, buy some of these top 10 very low cost no load S&P 500 index mutual funds directly. You do not have to pay the heavy added expenses of buying through a stock broker, financial adviser, investment adviser, or investment counselor."

Frank Knight presents Roth IRA Retirement Planning posted at Financial Planning Software, saying, "Roth IRA Retirement Planning -- Deciding between traditional retirement plan contributions and Roth retirement plan contributions"

Risk Management and Insurance

Patrick @ Military Money presents COBRA Benefits 2009 Economic Stimulus Recovery Act posted at Military Finance Network, saying, "The 2009 Economic Stimulus Plan includes additional COBRA and unemployment benefits."

Evolution Of Wealth presents Do You And Your Child a Favor posted at Evolution of Wealth, saying, "Do you depend on your child? That's what life insurance is for, to protect those that depend on you. What about the people you depend on?"

Patrick @ Cash Money Life presents Save Money on Auto Insurance Rates posted at Cash Money Life, saying, "Tips on how to save money on your auto insurance rates, including multi car discounts, multi-line policies, defensive driving courses, and more."

Savings

The Smarter Wallet presents HSBC Direct Review: Top Savings Account posted at The Smarter Wallet, saying, "Reviewing an online savings account"

KCLau presents Are You Rich in Internal Assets? posted at KCLau's Money Tips, saying, "pay attention to the internal assets"

Four Pillars presents $8,000 Credit For First-Time Homebuyers Extended 6 Months – Not Increased To $15k posted at Quest For Four Pillars, saying, "Home buyers credit extended 6 months."

KCLau presents Caring for the Elderly posted at KCLau's Money Tips, saying, "Problems faced by the elderly"

Taxes

Jeff Rose presents How to Qualify For a Tax Deduction on Your Traditional IRA Contribution posted at Jeff Rose.

Jacqulyn Richey presents First Time Home Buyer Tax Credit Extended posted at Las Vegas Real Estate News, saying, "A breakdown of the extension of the First Time Home Buyer Tax Credit. Now current homeowner may qualify for a credit under the new bill."

Super Saver presents End of Year Tax Planning - Deductions posted at My Wealth Builder, saying, "For me, October is a good time to review my 2009 financial status for tax return filing purposes. It gives me a few months to make any changes that can lower my taxes."

Mike Piper presents Tax Diversification: Roth IRA vs. Traditional IRA posted at The Oblivious Investor, saying, "Sometimes the best answer to "Roth IRA or Traditional IRA?" is "a little bit of both.""

That concludes this edition. Submit your blog article to the next edition of Carnival of Financial Planning using our carnival submission form. Past posts and future hosts can be found on our blog carnival index page.

Technorati tags: carnival of financial planning, blog carnival.

From concerns over unprecedented levels of government debt to making money from your old books @ The RoundUp

As I've posted last week I've sold the vast majority of my 6 month dollar cost averaging portfolio. The economic environment is too shaky for my taste. I'm willing to risk losing potential return since the risk I consider is a quick drop back to March 2009 levels. Assuming jobs won't improve any time soon I find it hard to see how governments will sustain growth through government spending alone. With each passing day risk of stagflation grows higher. Macroeconomic indicators aren't really proving any strong indication of the future.

The Stock market seems pretty relaxed, though. VIX volatility is down and things are calm. This may be attributable to the 2009 year end.

I'm on the sidelines waiting for a good opportunity to jump back in, slowly (Starting dollar cost averaging on a monthly basis all over again).

Interesting articles from leading economic and business magazines:

Stemming the tide @ The Economist – Concerns about Unprecedented levels of government debt (similar to those I expressed a week ago).

Managing A Portfolio With Hedgeable.com @ NY Times – A valuable portfolio management tool reviewed by the NY Times.

Money Issues That Can Test Even a Rock-Solid Marriage @ NY Times

Great personal finance posts from the past week's carnivals:

The Carnival of Personal Finance was hosted by M is for Money. Here are my favorite posts:

• 10 Things Your Baby Doesn’t Need that Can Fund Their College Education @ Fiscal Geek – Seems like many parents are frustrated with people trying to capitalize on their parenting instinct.

• How Our Consumer Debt Problems Got Out of Control @ The Digerati Life – A quick recap of the consumption craze.

The Carnival of Money Stories was hosted by Out of Debt Again. These posts caught my eye:

• Buying an Engagement Ring @ Dual Income No Kids Finance – Great story.

• Why Do People Pay More Money for the Top of the Line Model? Incremental Value Analysis @ Darwin's Finance – Interesting analysis of the premium paid on top of the line models vs. the incremental utility.

More from fellow personal finance bloggers:

Do Emerging Market Funds Belong In Your Portfolio? @ Amateur Asset Allocator – My answer would be – yes. How big an exposure would be the more difficult question. A good spotlight on the role of emerging market funds in your portfolio.

Sell Your Used Textbooks and Old Books Online @ Money Blue Book – Great guide on making some extra money on old textbooks and books.

How I Bought My Son $150 Worth of Cardboard Boxes (Or Free Box With Each Toy!)

Admiring the ability to enjoy the simpler things in life

As a child one of favorite sights was that of the suitcase my uncle had brought back with him from his travels. We always knew that bloated suitcase represented many mysterious and exciting gifts (toys of course) that can only be found abroad.

We were always very polite and waited patiently for the suitcase opening ceremony during which each of us received a present, thoroughly packed in wrapping paper bearing funny looking writing and smells of faraway places.

During the past decade I've been fortunate enough to visit my share of the world. However, only recently, with the birth of my Son I've been able to replicate those exiting moments. My wife and I are the only excited ones right now (he's 6 months old) but that didn't stop me.
Suffice to say walking into Manhattan's Toys R Us and FAO Schwartz had me leaving with a brand new 29" Samsonite and several pounds overweight.

Coming home, chest swollen with a new Father's pride I couldn't wait to show my wife my recent acquisitions. I knew she'd be proud of my toy hunting abilities and the new arsenal at the disposal of my Son.

I never noticed but it seems Duplo and Playmobil have really fascinating boxes. Apparently the contents were not nearly as exciting as the box that kept him busy for hours. Each corner, string and picture provided hours of fun either through banging or staring.

The mobile phone I bought, with numbers, letters and music which are activated by many colorful buttons came in a real neat packaging. It even stood upright by itself! The phone was cast away in minutes in favor of colorful yellow cardboard.

Seriously, I'm thinking of starting up my own toy factory for toddlers. Dorian's boxes and packages - all shapes and sizes. Why spend a small fortune on useless toys just for the packaging when you can buy as many as you'd like for the price of a single toy?

I'm currently in the seed level looking for investors. Would you be interested?

I guess I should be content. This phase won't last very long before toys get much more expansive, very fast. In fact, I've been trying to convince my wife we need a Playstation 3 since our son was born. I'm still counting on him to convince her we need it.

There's something beautiful about the total lack of materiality in babies. They are truly able to appreciate the free things in life such as a hug, a package, a tree branch or anything else of this sort. For some reason we lose it along the way.

Related Posts:

• Challenging Happiness – Exploring the Irony of Human Nature
• Is Rationalization the Key to Happiness?
• Behavioral Finance in Everyday Life – The Lottery as a Case Study
• Success: Who Dares Wins?

6 Figures at 28, Leveraged portfolios & causation @ The RoundUp

The better posts from fellow bloggers this past week include:

The Financial Fallacy of Patterns, Causation & Correlation @ The Financial Philosopher
Great post. The problem with patterns runs even deeper. Even if a pattern has been spotted it says nothing as to the related causality. Correlation is the bane of many of the social sciences, including economics. I've written quite a bit about it. Hume's brilliant analysis of the problem of induction is perhaps one my most favorite philosophical text as it leaves you shaken by the sheer truth of the arbitrariness of empiricist life. A fascinating subject. My thoughts On Causality and Correlation in Economics can be found here.

Five things to do for the baby before returning to work @ The BagLady
This topic has grown very close to me these days. I'd add: Prepare Mommy for post maternal leave life – The level of how our priorities changed amazed me even though I had given this issue much though. Suddenly we're there for another. That is a significant change I've yet to fully comprehend (after 6 months).

Hitting 6 Figures Income at 28! @ The Financial Blogger
Congratulations on hitting your mark! I believe 6 figure income is a state of mind, so to speak. The post includes several tips on how to achieve such a goal. From my experience, everything amounts to commitment and understanding of the broader picture. Adopting a pragmatic point of view according to which you have to earn rather than hope to get recognized is crucial. Too many employees believe they are entitled to much more than they are getting. This is a self-destructive point of view. The pragmatic approach suggests doing your best in a given job or seeking out alternatives on your way forward. Career management is an active endeavor and one should not hope for things to improve but work to improve those.

Are you as leveraged as Goldman Sachs? @ Gather little by little – On the importance of understanding leverage and one's real portfolio.

Retirement Investing Advice For Late Start Investors @ The Digerati Life

Dow Hits 13 Month High on Decision to Keep Aid Flowing to the World Economy

My fundemental reasons for concern

As several of my last posts indicate I have whole heartedly adopted Dollar Cost Averaging as my investment strategy. The reasons have been discussed in length a few posts ago.

Today I thought about liquidating some of the investments I've made in the past 6 months due to the negative vibe in the market encouraged by leading economists and investment gurus such as Noriel Roubini, George Soros and Bill Gross who all attribute a certain bubbly taint in the markets.

Good thing I didn’t. I might, though, tomorrow.

The reason that kept me from selling today was my attempt at disciplined investing and self restraint. Still, my fear of a near drop in stock prices only grew today. The reasons for my fears are:

The low interest rate environment as a catalyst to bubbles – Low interest rate drives investors wild. Risk appetite is gradually growing seeking alternative means of generating returns slowly yet surely forgetting the risks involved. In a 0.25% interest rate environment an 8% return reflects a 7.75% (!) risk premium. We must not forget that.

Many stocks have regain past losses and some are close to 2007 levels than ever before – There is no sign the economic growth is stable enough for the long term to justify such a prices level.

The markets are running on the government expense fuel – Bank earnings and growth is generated mainly through increase government expense with no signs of private sector backing or growth. How long can governments keep this up?

Fear of stagflation is real – Stagflation, the situation in which both inflation and economic stagnation are present is more and more a reality with each passing day. Price levels are bound to rise eventually due the huge amount of money being dumped on the markets by the government. Eventually the weak dollar may get weaker while the economy hasn't regained in full (again, very dependent on government expense).

Technical analysis points to diminishing volume of trade in recent stock price increase – The trade volume does not support the trend. This is cause for concern from a technical analysis perspective. Just look at the trade volume today.

The markets rejoice as government aid continues. This is a risky game. Any market position, whether short or long is a risky wager. I'm seriously thinking of adapting my strategy for the short term. Tomorrow I plan on restarting my dollar cost averaging after realizing some of the gains I had made during the past 6 months.

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A Temple Restaurant and a Clearing House for Tickets – Two Observations of New York City

Best City in the World

New York City is my favorite destination in the world. Any opportunity to visit again, whether on business or pleasure is a joy. With each visit a new light is shed on some other aspect of the city. I'd like to share two such spotlights with you.

In case you have been wondering The Personal Financier is very much alive. It may not seem so but I'm doing my best on getting back on track. It's amazing how life changes once you have a child.

Peter Luger – The Mystery of Building a Lasting Brand

Peter Luger offers the best steak I've had my entire life. That's a fact on my part. I may be biased but I don't believe the brand has enough influence on me to force such a belief. It is truly remarkable.

Still, that rarely justifies the lasting brand name Peter Luger has made for itself and has been successful at maintaining for the last century. We all had great meals at great restaurants, some more hidden than others. Still, such a strong, international brand name for a steakhouse is a remarkable phenomenon.

Location? What is so great about a 15 minute train ride from Manhattan down a grimy Brooklyn Staircase only to walk 5-10 more minutes in the rather unattractive surroundings of Brooklyn's Broadway Street?

The restaurant? I've seen much better looking classic restaurants preserving the glory of days past in wooden furnishings.

The service? It may be characterized as slightly snooty with a "thank us for considering you a potential diner" attitude at times.

The food? I've already mentioned the food but that is not enough. It is probably the best Steak I've ever eaten but I've eaten ones that got pretty close to it as well.

It seems the Peter Luger charm is a complex one. And as always, the answer with complex is everything. Everything from the location to the design and attitude constitute the brand which is Peter Luger and assure my returning on any chance I get.

The relatively remote location suggests a good thing deserves the effort. It gently insinuates that the steak is that good it does not need a prime location and subtly differentiates between the connoisseurs and the herd (You being the connoisseur if you've understood the trip to be worthwhile). It suggests the steakhouse is a temple for meat lovers who would gladly take the pilgrimage to pray at the altar of porterhouse.

The restaurant's classic design supports these gentle innuendoes with classic appearance and sacred design. The temple of meat will forever be as it is. A holy place, unchanged with time.

The service is suggestive, as if you acknowledge the sanctity of the place and its guardians and decided to entrust yourself with their capable hands. They simply know their steak is that good.

TKTS – Ingenious Broadway Clearing House

I believe the first thing a tourist planning a visit to Manhattan writes down is "Get Broadway show tickets at TKTS". To his or her content a blow has been struck against the Tyranny of Broadway theaters and their exorbitant pricing. Simply wait for the last minute and the giants of Broadway will fold offering 50% discounts to the witty traveler.

The lines at 47^th Street and Broadway are always full of conscious, self-assured consumers who know how to enjoy a show at a reasonable price. I used to be one of those standing in line, content to have purchased discounted show tickets thinking I had outsmarted the world.

TKTS provides a good deal and an important service. The fact is, however, that much better deals are available with little or no line at all, and better yet, you can select the date on your own. These are ironically available at the theaters themselves. The same ones we thought we had outsmarted.

On my recent trip I learned visiting the different theaters is much more worthwhile than waiting the TKTS line. All theaters offer much cheaper Balcony prices for all available dates. Usually, for most shows, an upgrade to better seating is available once the show had started, curtsy of the usher. At TKTS you'll get good prices but on much more expensive tickets, usually ending up seating in the same location.

TKTS is ingenious. Broadway owes much to whoever came up with this successful clearing house for theater TKTS. In my opinion this is the main idea behind this initiative. Broadway tickets were standardized, seating availability made common and all that was left was centralizing the selling point in the prime location it is currently located in.

Curtsey of the Theater Development Fund Broadway theaters enjoy a great selling point, cleverly marketed and ideally located. The stress on theaters boxes is lessened and tickets are sold throughout the day assuring seating is maxed out for every show.

The selling technique also contributes to TKTS performance as the pressure on the client is significant as he or she is holding up the line. Prices are quoted rapidly for each show with little time to ask or wonder. Decisions are made and tickets are sold.