Hey Son.

Hope things are well. At this time all you are supposed to do is eat, crap and sleep, thats it, nothing more nothing less. Daddy and Mommy are really happy that you are here. These are your formative growing years so how about we start with some lessons on behavior.

Most humans have what we call cognitive biases, these were great things when we were evolving from animals, but cripple us today. A lot of research is now being done on this topic and marketers have made a fortune using these biases to make money of you. So its a good idea to understand what these are and how to counter. We will talk about two big ones today, Confirmation Bias and Loss aversion.

We humans are by definition, social animals. We love to be loved and agreed with. Most of our life is spent forming decisions and interactions where we essentially want people to like us and agree with what we think. The side effect of this is that once we understand something or think we understand something and make a decision, we like to stick by it. Come hell or high water! Even if all the evidence says that its wrong, we still want to stick by it. We will go out our way to get data that confirms our decision. This is the essence of confirmation bias. This *will* bite you. But fear not there are ways to counter this and its relatively easy. Develop a mindset that always starts with the assertion that you don’t know everything. Have a healthy dose of skepticism when you are deciding something or trying to understand something. Always be thinking  “whats the catch”, is there someway that you can get data to disprove your theory? You should always bounce your ideas off somebody who you know will have the opposite stance, somewhat of a devil’s advocate. Always keep an open mind and never be trapped by what was done in the past. Look ahead, form your own opinions and always challenge them.

We humans hate losing. Losing hurts way more than the happiness we get from winning. This manifests itself time and again in the investment arena. For example, say you buy a stock and the stock tanks. You don’t sell the stock because if you sell now, you will make your loss real. That hurts, so you hold on to the stock expecting it to come back up and make money. This is classic loss aversion. Before buying into any investment do your research and have a pre-determined exit point if the stock starts losing value. You will make mistakes, but this pre determined exit point is your fail safe mechanism, your backup plan. This will ensure that you sell your losers quickly. Don”t keep holding on to them, sell em and move on.

In other news, the past month has been great the world over for stock markets. The S&P finally broke through 1500 and is back to pre crisis levels. Looks like the markets are really happy that you have arrived 🙂 However, a lot of the structural problems that caused the GFC haven’t really been solved, so it is very interesting to me how the the market is acting like “all is well”. What to make of it, I don’t know. If you believe in mean reversion, we are due for a collapse, but you can also make argument that the same crisis cannot happen again, so all is well. Goes to show that predictions about the level of stock markets is a fools game :).

All right that’s enough for today. g’nite, sleep tight.

-Dad

On Today February 22 2013