Learning the financial language will save you money

Proficiency in "Financialish" equals money and empowerment

According to one urban legend the score in tennis matches was meant to confuse the common bystander, safely maintaining it within the confines of aristocracy. Other explanations include a clock face used in medieval French for scoring the game moving a quarter each time and the different gun calibers of English naval ships (15-pound guns on main deck, 30 pound guns on middle deck and 40 pound lower gun deck).

I've also encountered a similar explanation as to the reason why the French language holds so many "redundant" vowels. According to this myth the French royalty added a bunch of complicated phonetic rules the French writing to make it harder for the commoners to develop reading and writing skills.

It doesn't really matter whether the aforementioned is true or false. The point of these arguments, as we all know, is that knowledge is power.

Proficiency in the financial language is directly translated to money saved or earned

Language is a form of skill and knowledge which empowers the ones proficient in it.
The current crisis, for example, has everything to do with ignorance or lack of proficiency in the more complicated aspects of the financial world. Complicated derivatives and structured products drove the world crazy, making regulatory financial reporting such as financial reports completely useless for investors.

Warren buffet had identified the problem with derivatives as early as 2002: "I view derivatives as time bombs, both for the parties that deal in them and the economic system… derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts… ".

We don't have to as far as derivatives in order to demonstrate the importance of proficiency in the financial lingo. Many of us are completely puzzled with even the most basic conversation with our banker. The terminology is perplexing and no one really likes to admit one doesn't understand.

Be sure enough banks and financial institutions are quick to exploit on this tendency. A less known fact is that most of the bankers we meet in banks are really marketing personnel "in disguise". It's very simple really. The bank's goal is to sell financial products (loans, credit etc.) in high prices (interest). In order to be smart consumers we must first understand what this guy in a suit is talking about before we are able to be more confident in our negotiations.

It's really not that hard. Much like any other technical terminology the financial language may seem, at first, to be complex and full of subtleties and innuendos. At its higher level this is definitely the case but as with other things in life you can get a good comprehension of about 80% of the subject matter with 20% of the required investment (read this post on the 80%/20% rule). Just be confident enough and you'll be surprised of the results.

When one is proficient in a language one is confident. Suddenly bankers will start mumbling around you and will be turning much more to their manager when suddenly explanations and deviations from the standard pitch are required. This is literally worth money.

Where to start? Or is there a dictionary?

My idea for this post sprang to mind when Oxford university press were kind enough to send me a copy of "The Finish Rich Dictionary" by David Bach, an author of many other personal finance guidebooks.

While I'm less fond of the ever-promising title I did actually find the idea behind the book to be quite helpful. Much like any other language we need a "Finance to English" dictionary which will help in learning Financilsih.

David Bach has cleverly constructed this dictionary 1001 financial words "you need to know" are alphabetically organized and explained. The book is intertwined with helpful personal finance essays which discuss the issues at the very core of our personal finances including: Credit card problems, compound interest, the workings of the Federal Reserve, insurance, buying a home, money mistakes, financial plans, retirement, financial advisors and others.

The book also includes good references to other helpful resources and a interest rate risk calculator to complete the package.

I do feel the added value of this book should be articulated carefully since lack of financial resources is not something the internet is characterized by. This book is helpful as a glossary of words, combined under one roof, which maps the very basics of the financial language. If you don't know where to start this book may very well start you off in the right direction in an easy manner.

The interest offers much more diverse and deep knowledge resources of several kinds I highly recommend to anyone, no matter how proficient in the financial world:

• Wikipedia is without a doubt one of the best knowledge resources available to us, free of charge. Most of the entries are very comprehensive and well articulated. I often turn to Wikipedia first to find out more on a certain subject matter.
• Another helpful online dictionary is Investopedia which is centered around finance and investments.
• Finance blogs are great resources for financial knowledge. Blogs, such as my modest Personal Financier, aim at expanding financial literacy and discussion and are home to many good articles and advice. My link section has many helpful blogs listed. Some of my favorites include The Digerati Life, The Financial Blogger, The Simple Dollar and other more I apologize for not being able to list here.
• MSN money, Yahoo! Finance, NY Times (Your money section) and many other offer invaluable knowledge on personal finance. The problem is usually where to start from.

Whether you prefer a book to the internet or vice versa don't neglect your financial education. It's worth money.

Related posts:

• Behavioral Finance in Everyday Life – The Lottery as a Case Study
• Review: The Gone Fishin' Portfolio by Alex Green
• The 80/20 Rule - Let Pareto Do Most of the Work

Behavioral Finance in Everyday Life – The Lottery as a Case Study

Is lottery a tax on stupidity or are our flawed psychologies playing another trick on us?

My wife and I usually enjoy strolls around our neighborhood on weekends, especially on sunny winter days. We live in the city and in our last stroll I kept noticing lottery advertisements everywhere as if they were beckoning to me.

Lottery has been deemed a tax on stupidity for a good reason. Every smart and aware consumer knows better than to throw money away on odds smaller than those of getting hit by lightning 3 times in a row.

Still, I couldn't help but buy a ticket. I felt I'd be I'd ignoring all the signals I had received that day calling out to me: buy and ye shall win. After having bought the ticket, for some reason, I'm full of hope and a very strong sensation of confidence in my chances of winning something.

I'm sure many of you have experienced that feeling before as well. Somehow, even though I am aware of the slim odds an unjustifiable feeling of optimism surges and the thoughts of all the things I'm going to do with my soon to be acquired financial independence overwhelm me.

There's a certain bias at work here and as my readers know I love psychological biases. This feeling of elation and of profits to come reminded me something. I usually get the same feeling when I make a stock investment. I simply can't be more certain this particular stock will drive my portfolio to new highs. Where does this conviction come from?

Behavioral finance and hedonic psychology - Daniel Kahneman and Amos Tversky's work

Daniel Kahneman is an Israeli psychologist and Nobel laureate, notable for his work on behavioral finance and hedonic psychology. With Amos Tversky and others, Kahneman established a cognitive basis for common human errors using heuristics and biases, and developed Prospect theory.

Kahneman and Tversky's work on behavioral finance is one of the most interesting and important to anyone who wishes to learn of the limitations of human rationality and the psychological biases that play a key part in our "rational" thinking. Their work is very relevant for investors everywhere as it ties in very tightly to stock market success and failure due to the affects of psychology on us, as investors or traders.

The Representativeness Heuristic – A wrong perception of chance

Would you choose consecutive numbers like 1,2,3,4,5 for the lottery? I'm guessing that you won't. But why not choose these numbers?

1,2,3,4,5 have the same chances of appearing than 2,8,12,23,35 but the last seems much more probable to be the winning numbers due to their randomness. Our minds are programmed in such a way as to correlate order with intention, which is mostly true. Still, there are times when this is obviously false.

The same phenomenon exists in the roulette where the combination red-red-red-black-black-black is thought of as much less likely than black-red-red-black-red-black. We have a certain expectation of nature restoring order to it, offsetting the results.

The Overconfidence effect and Optimism bias

Very common in investors the overconfidence effect is a bias in which people are correct in their judgments far less often than they think they are. For example, for certain types of question, answers that people rate as "99% certain" turn out to be wrong 40% of the time. Overconfidence is one kind of what is called the miscalibration of subjective probabilities.

You really can't get any more optimistically biased than hoping to win the lottery against unbeatable odds.

Apparently the lethal combination of overconfidence and optimism bias is very common and very hard to resist. According to Kahneman and Tversky only seasoned stock market brokers, weatherpersons and dog track analyists have shown some resistance to the effects of these biases.

I'm still hoping to win something but somehow I'm a little less confident in my guesswork. Still, people do win.

If you find judgement under uncertainty and heuristics and biases as interesting as I do please let me know. In the near future I hope to write more on these issues. In the meantime, you may be interested in Kahneman and Tversky's Judgment under Uncertainty: Heuristics and Biases

Related Posts:

• Valuation and Risk Measurement Models under Heavy Criticism – What Went Wrong?
• Coming To Terms with Never Getting Rich – A Look at the Pre-Requirements
• Key psychological factors in stock market success
• How Can they Possibly Afford That? Or Is Money in the Eye of the Beholder?
• Outsourcing Our Chores - Do We Overvalue Our Spare Time?

Review: The Gone Fishin' Portfolio by Alex Green

The Gone Fishin' Portfolio offers a framework for saving, sound investment wisdom and no less important a step by step approach to their practical application up to a detailed asset allocation.

When I read through the first couple of chapters of The Gone Fishin' Portfolio by Alex Green I was surprised to find a philosophical reference to Plato's Apology and the Socratic Method. One of the bases of western philosophy, the Socratic Method dictates the constant inquiry of premises and assumptions and encourages an oppositional discussion as a path to knowledge. The Socratic Method is therefore a double-edged sword the author may end up facing himself. That was not the case.

Skepticism and the Socratic Method are a promising start to every book

As the story goes the Oracle of Delphi pointed Socrates out as the wisest of men (and women). Socrates, thinking it a paradox, set out to prove the Oracle wrong and turned to the wisest of Athenians who surely held knowledge that surpassed his own. Using his famous Socratic Method Socrates revealed none of these wise persons really held true knowledge as all failed to explain their concepts of truth, justice, good, beauty and happiness. Socrates found the oracle to be right as he was the only one aware of his ignorance, paradoxically making him the wisest of Athenians (He simply knew he didn't know). The author makes an equally strong argument when it comes to investing and managing our money.

The lesson Socrates had taught the world is a powerful and important one and when it comes to investing it seems we sometimes need a reminder. An author that advocates skepticism at the start of his book has already earned considerable credit in my eyes.

What is The Gone Fishin' Portfolio about exactly?

As aforementioned, much like Socrates, the author lays no claim to knowledge that is not available or is out of reach for all of us. The author quickly lays bare the claims of Wall-Street to "professional knowledge" which we, household investors lack. The case against professional money management is a bit strong, even demagogic at points but is essential for the author's main point. Managing our money isn't as complicated as other may want us to think.

The Gone Fishin' Portfolio is a book aimed at the household investor surrounded by never ending piles of knowledge leaving him (or her) even more confused and baffled. The book offers a simple and robust investment strategy that has proved itself over the long haul.

Much like Socrates and his paradox the author does not claim to hold knowledge of any special investment strategy which will enable us all to generate phantasmal abnormal returns. You will find no secrets to timing the market as there are none and you will be disappointed if you're looking for a safe riskless investment strategy that will generate return out of thin air (again, there is none).

The author simply turns to old investment wisdom that relies on the basics of finance. Long term investing, diversification, varying levels of correlation and wise asset allocation are fundamental to the approach offered by the author. That is also possibly the book's main shortfall. The book lacks in innovation but most certainly makes up for it in sound investment advice.

The book offers a specific portfolio and is aimed at the majority of household investors who wish to wisely invest their savings and spend as little time as possible maintaining them (which is, by the way, great advice for long term investors). The portfolio offered by the author is a sound one and is allocated very much accordingly to the text book.

The book offers more than just a portfolio. It offers a framework for those of us who seek a comfortable retirement and wish to balance the risk of a financial shortfall with the risk inherent to financial investments. It points out the conflicting interests many money managers face when dealing with out savings and sheds light on various financial truths with historical evidence.

I believe The Gone Fishin' Portfolio serves as a good financial education book and I would recommend it to those of us who are less proficient in finance and investments and are taking their first or second step in the saving world. For the more proficient of us who understand good asset allocation, the CAPM model, the importance of long term investing and discipline and the crucial difference between investing and trading this book might serve as a good reminder of the basics.

The book is well written even if a bit simplistic at some places. The author effectively repeats and stresses the main points brought forth and conveniently sums the essence of every chapter at the end.

What would Socrates ask after reading The Gone Fishin' Portfolio?

As the Socratic Method dictates I'd question two main issues. The first one is the level of risk offered in the portfolio. The author suggests a very detailed portfolio which comfortably enough leaves only with the buy command and yearly maintenance, which is really a breeze. The asset allocation offered is relatively aggressive with 70% stocks in the portfolio. That is very important for long term savers. Arguably, as the term of investment shortens it is important to consider the level of risk taken (read Long Term Investments Are Not Risk Free for more on the subject).

The second thing I'd question is the array of Vanguard mutual funds recommended. The author recommends, very wisely and objectively, to invest in index funds which are less costly in commissions when compared with managed mutual funds which have not proved to outperform the markets (on average, it's actually the other way around). The author recommends Vanguard funds in terms of cost effectiveness. I'd test this premise before investing but the concept of the portfolio is true enough.

The Gone Fishin' Portfolio apparently outperformed the S&P for the last 5 years but that is not something to take for granted (that is do not assume it will continue to do so in the future, as the author points out). Naturally the author does not promise the portfolio will outperform the S&P every year and he very well shouldn't. The strength of the Gone Fishin' Portfolio is in its utilization of basic investment wisdom of long term asset allocation and rebalancing which has proved itself in the past (read Know your Portfolio - Three Simple Charts Can Make a World of Difference for more on the subject).

Disclosure: Book reviews on The Personal Financier are entirely objective and are not paid for or sponsored in any way by the author, publisher or any other third party. The Personal Financier receives a 4% share of books sales referred by us which help support the efforts on this blog.