Is Personal Finance a Science?

and now the part of the evening we've we've all been waiting for first of all let me assure you you will not be deprived of dessert dessert is going to be served quietly and surreptitiously while we listen to our next speaker and it is my great pleasure to be the person who's going to introduce Paul Samuelson not not all great scientists are also great teachers Einstein was a great scientist but he relied on others to explain his scientific theories to beginners and to non physicists Paul Samuelson however is universally recognized as both a great scientist in my judgment the greatest living economist and a great teacher the greatest teachers have two traits in common they have a passion for their subject and they take pleasure in sharing their not their knowledge with the broadest possible audience even before he became the first American to receive the Nobel Prize in Economics science Paul Samuelson became famous as the author of the leading introductory textbook in economics aptly entitled economics my personal relationship with Paul began through his textbook when I was a high school senior in Brooklyn Tech in 1959 I don't recall which edition we studied but since the first edition was published in 1948 my guess is that mine was the third or fourth anyone who reads Samuelson's textbook comes away feeling familiar with the author the Congeniality and the wit shine through its pages the writing style is casual yet very precise in 1998 on the 50th anniversary of Samuelson's economics mcgraw-hill the publisher published a reprint of the first edition I got a copy and read through it for the first time I was amazed to discover that a contained far more practical personal economics career choice personal investing than the subsequent editions that I had studied myself in high school and then taught later as a professor of economics I think it is fair to say that with each addition more and more of the personal economics was dropped and replaced with more on government economic policy and the technical models used to analyze government policy perhaps Paul can tell us why my guess is that econ professors who are the ones after all who choose the textbooks wanted to teach more technical economics in the introductory course so the more practical material was crowded out Paul's range of published work is by no means confined to his textbook and his articles in scholarly journals he takes the light in writing for the interested layman for several years in the 1970s he wrote a column for Newsweek magazine how many of you used to read that his articles were as simple as possible but never simpler he once wrote a column using only one syllable words and it was about finance that's correct finance in one syllable a recurring topic topic in these Newsweek columns was what economic science tells us about how to invest he was an early and steady advocate of index funds as a low-cost efficient method of investing in a diversified portfolio he has consistently warned against believing the mistake in proposition that in the long run stocks are sure to beat bonds there is no one more suited than Paul to open a conference devoted to the application of economic science to improving the practice of life cycles saving and investing I give you Paul Simon's they tell me that when you're drown your whole life goes before your eyes it's a little bit like that when you get a long introduction but but but it's worse than that when the introducer steals so many of your punchlines still I will struggle on the title I was assigned was his personal finance of science and I think that that title is ill expressed it's wordings might seem to be asking his personal finance and exact science and of course the answer to that is a flat no and so if this disappoints anyone in this audience now is a very good time to rectify your miscalculation by leaving what I do hope to address is what kind of inexact science personal finance is actually earliest political economy in Aristotle or even in Holy Scriptures began as the management of the household you can't be more lowdown personal than that my Harvard mentor Joseph Schumpeter in a crescendo of brain storming once went so far as to claim that solving the numerical problems of economics one Pig for three hands rather than for four or five was the effective Darwinian evolutionary selection force which made us humans become human Descartes opined I think therefore I am Schumpeter out opined Descartes asserting because we humanoid primates had to struggle with personal finance we became human well in our introductory economic textbooks which have been mentioned here Robinson Crusoe always played a starring role and rightly so some 50,000 years ago agriculture broadly defined was the only existent industry each farm and hunting family had little reason to trade with their 22:15 own neighbors neighbors who were virtual clones of themselves I do not jest as recently as around nineteen seventy one of my many sons spent his summer away from Milton Academy with his new temporary mother on a peasant farm in Lower Austria that's a region where no marriages took place before the female candidate proved her fertility by becoming pregnant and so along with his newly widowed mother he acquired a new older brother virtually all that the family consumed was grown on their peasant farm slaughtering the hog was a big event of the summer and nothing in that hog went unconsumed pure personal finance once again but alas deviled nicotine ended that bucolic scenery of self-sufficiency his new brother became addicted to cigarette smoking this requires cash and to get cash you must shift to some cash crop for the first time that's more or less how and why personal finance became perforce market oriented as it is today almost everywhere well I spoke of elementary textbooks and so did steal my bog Rahil bestseller came out back in 1948 for the 50-year celebration of it I had to reread the brainchild when Samuel Johnson we read his failed play Irene he said alas I thought it had been better mine was he mine was the opposite reaction God how goodness this was I discovered that apparently mine was the first Primmer ever to devote a full chapter to public personal finance series II savings bonds diversified mutual funds how much more sons-in-law and who are doctors and lawyers than clergymen dishwashers cab drivers orcid ographers human capital I never got a Nobel Prize for it fifty years later I was pleasantly surprised to read you know this is a boasting lecture I was pleasantly surprised to reread in the new facsimile edition of that 1940 in original much like the following words this is a paraphrase of course America's post 1935 social security system whose creation I was in on which was formulated deliberately I don't want to lose any pearls of wisdom in Depression times to intentionally discourage savings and to coax into retirement job huggers of course that will have to be abandoned in the future as a pay as you go non actual financial system such the systems begin with seductively favorable pension rates that are transitional only and must mandate stiffer contributions in future stationary or declining demographic states 19:48 not too bad hold the applause this was apparently one of my first initiations into overlapping generation economics you might even say that in my small way I was then being John the Baptist to latter-day Larry Kotlikoff who is known deservedly around Central Square as mr. generational accounting lifecycle finance ala Franco Modigliani recognizes that as mammals we all do begin with the free lunch as mortals we are all going to die but prior to that event with few exceptions will need to be supported in retirement years by personal finance and as we used to think before Reagan and the two Bush's old-age pensions might come partly out of Social Security public finance my brief words here will focus on personal life cycle finance that is a domain full of shucks shucks ordinary common sense alas common sense is not quite the same thing as good sense good sense in these esoteric puzzles is hard apparently to come by here's a recent example lifecycle retirement mutual funds are one current rage fund a is for the youngster in this audience who will be retiring in 2042 I suppose that's our Federal Reserve Chairman call cholerae be is for 2015 retirees an A and B's lifecycle fund both might begin with say 65% in risky stocks allegedly risky stocks and 35% and allegedly safer bonds but even without anyone having to make a phone call B will move earlier than a to pare down on risk these risky stocks and gusoff exposure to safe bonds perhaps the editor of this series will remove the verb goof goose from my important text the logic for this apparently is simple as simple as that two plus two equals four and that the next nine years is a shorter horizon period than the next 36 years that law of averages proved over and over again in Las Vegas or even at the ballpark tells us allegedly tells us that riskiness for a pulled sample of say 36 items is only half what it is for a pulled sample of only nine horizons the well-known square root of n verity or the not so well known square root of n fallacy now Milton Friedman is surely no dummy just ask him maybe he'd recall from his course in statistics that the ratio of square root of 9 to the ratio to square root of 36 measures how less risky stocks are in the sense that the long horizon portfolio endures only half the stock riskiness of the short horizon portfolio you can see I've been paid by speed Bodi to spread spread is poison poison but don't copy down my fuzzy arithmetic it's only blue smoke sound and fury signifying nothing actually I have three stripper sons that's the only true part of the story I'm about to say I'll call him Tom Dick and Harry to protect their privacy all three are risk-averse chips off the old block they're very risk-averse with their money but they weren't that way with my money this means that unless the mean gains of a portfolio exceeds its mean loss they'll avoid such an investment however Tom is less paranoid than dick well Harry is even more risk-averse than dick nevertheless this is all lies all three will shun life cycle funds for each of their 25 years until retirement each will hold constant the fractional weight of risky equities Tom's constant is 3/4 equities 1/4 bonds Dick's is half and a half suspicious Harry stands at only one quarter by the way it would be better to make that suspicious Harriette but the president Harvard got in a lot of trouble with that kind of conjecture nothing is off the record these how do I know that because in my family we do our own cooking also alive I have written seventy eleven learning papers denying that the correct law of large numbers indicates the common sense erroneous notion about risk of erosion when investment horizons grow from one to ten or from 100 to ten thousand now if you think I just criticize the idiots who belong to behavioral science you you underestimate me I criticize the pure mathematicians from Berkeley and Bell Labs who say that's wrong what you should do is you should maximize the rate of growth of a portfolio and you should behave like a geometric mean maximizers and I've written ninety 11 papers controverting that view well mine has been the Lord's work but it has brought me no second Nobel Prize he complain complain complain but even when I go to write articles using only one syllable words to rebut the many pure mathematicians who believe that all of us should see going to maximize our portfolios long time growths I'm like Roger danger to feel I get no respect and I get no converts my doctrine is applied math is too important to be left to pure math types and also too important to be left to idiots I can soul my wrists self though by repeating over and over Mark Twain's wisdom hold your breath you think he's just a humorist you know in kindergarten I was not very good at separating pages quote you will never correct by logic a man's error if that error did not get into his mind by logic by the way we should put that in the plural and make a gender free it would apply well with svevo D on this program I could hurry on to new personal finance topics surprisingly housing will be one of them why housing in a personal finance seminar life cycle personal finance seminar I'll leave it to Gales Bob Shiller or Wells Li's chip chase but not before articulating my 1958 point on overlapping generations that money aside people's homes are an ideal contrivance for converting working age savings into retirement de dis savings I even wrote an unsuccessful forward for a little book on the the disappearing Mortgage Riva Poor's book a good cause that never got very far it was ahead of its time well President George Bush has advocated so far unsuccessfully that those of us covered by Social Security should be allowed to transfer into our own accounts our fair share of what's been paid into the public fund on our account that way the I'm quoting the long-term sure thing surplus yield of common stocks / bonds can be a wind at our back augmenting our golden years of retirements besides his words it's our money not the government's well don't shoot the piano player I'm only quoting from White House handouts I'm not a prophet I can't guarantee for you that risk corrected stocks will outperform bonds from 2006 to 2015 however if the US electorate wants to drink from that whiskey bottle and bet on that view private accounts are not the efficient way to implement it ask mi t--'s Peter diamond for sermons on this topic a century of economic history about private and public financial markets strongly nominates one huge diversified index social security fund utilizing both stocks and bonds and both domestic and foreign holdings and the bat-file produced for the next generations better retirement pensions along with what's important better sleep at night and one of its unique often overlooked virtues is that beneficial mutual insurance reinsurance among adjacent generations becomes possible under that arrangement of course this sensible good sense sensible not common sense sensible proposal is too efficient ever to be adopted to adopt it would free some millions of financial employees to transfer it builds up suspense Dennis the man's work is never done transferring to useful plumbing beer brew brewing or barbering never forget the old saw insurance is sold not bought people have been shocked and I've testified before Congress about 50% loads on various guaranteed funds and they never realized since the beginning of time every insurance salesman has always gotten at least 50% of the first year's premiums same goes for stocks bonds and lottery coupons plagiarizing Abraham Lincoln I can say God must love those common folk the behavior science economists write about because she made so many of them fortunately there I have to end with a good note there have been some good social inventions if the poet browning asked me did you see Shelley plain I have to answer no but I did see close up my harvard graduate school buddy bill green oh it was his harvard PhD thesis that invented for tiaa-cref the variable lifetime annuity invested efficiently in common stocks my secretary has four invested invented efficiently and investment efficiently and early on I did write blurbs for Jack Bogle successful launching of Vanguard snow load rock bottom feed S&P 500 stock mutual funds God is in the ad-libs so if I can interfere with myself some mistakes in life have been happy mistakes I'll go outside of my field of economics to different field Enrico Fermi a great Italian experimentalists and theorists split the atom in 1934 he didn't know he had done it he wasn't interested in the energy things he put paraffin over his equipment to suppress the energy effects but by 1939 lighter and a woman and her nephew fresh deduced that he had actually split a larger molecule into two small molecules and Savard a learner like eccentric actually patented this way of creating energy why do I say that was a happy mistake just delay of five years because without any doubt if it had been understood in 1934 Hitler in 1939 would have had a nuclear fission bomb and not only would history be different but perhaps the planet would be different well the discovery or the implementation of the low load low expense low activity S&P 500 of the Vanguard type could have followed the exchange-traded equivalent of recent times I think that the it's pretty much an even-steven thing and it's an illusory that you really have an advantage of being able to call any time of the day and trade but I know human nature and the invention of that would have been not serving my risk-averse triplets it would be serving the people who won action in Las Vegas would like to have it equally in the Chicago Board of Trade exchange exchange-traded so it was better that the prosaic mutual fund form got to start before the other one of course this is all personal opinion and you have to take it with a grain of salt well along with the chimpanzee hero who invented the wheel and those Neanderthal heroes who discovered how to make cheese cheese and how to make cider hard cider in my Bell holla of famous heroes you'll find the names of Greenough and Bogle my final words are cut short by this audience's somewhat well-fed drowsiness I'll leave as questions for later discussion will hedge funds make our Golden Ears more golden or will the new products of option engineers instead of reducing risks by permitting them to be spread optimally in fact by making possible something like hundred or one over leveraging result in micro losses for patient funds or even threaten the macro system with lethal financial future implosions good teachers always end their lectures with a question that's what I've done unfortunately if you can say the course maybe Bob Merton will give the answer to my last question thank you if we have a time for questions we definitely have some time for a few questions do we have here's a mic so if you have a question raise your hand there we go so how should the social security system be be transformed well I don't know why are Peter diamond wasn't John Chauvin is here and probably ready to leap to his feet answer your question not tonight though John John says not tonight I don't think by the way that it's a a girdle like a solvable question there are lots of sensible ways of I'm doing it yeah that is that is going to be a big part of session five on Friday morning Jeff can we expect individuals to know enough about what they're doing for their own financial responsibility to take responsibility or are we obliged to basically not allow them to have that responsibility and somehow do them for do it for them I don't think Darwinian evolution is very slow and so all of you here have about the same brains that Cicero and the classical people had so I don't think people are going to automatically get wise these are complicated questions the part of behavioral economics which is very important is a psychological fact which you appreciate even more as you get older Skinner isms do it now Fred Skinner says if you see a weather report it's going to rain and you're over 39 take your umbrella and put it on the door so that you will have that that crutch to take the umbrella so the various ways in which kindly and intelligent corporate employers organize for their employees the defined defined contribution systems are extremely important and those automatic things where deal clever default choices that are made automatic I think will help a lot it also it'll also help if there is a great core of well-informed financial advisors who in arm's length transactions with people who need their information will provide it I have taught at MIT for 65 years in the course of time there have been a number of dead professors and often a dead professor just the way we live leaves the widow more widows and widowers and somehow to my door come a procession of widows it's not trade I buck for and the question they ask me is where can I get good financial advice and I've been steaming I've generally said beware the people who give you free financial advice because I learned the most render stories but people who for example within the year are gonna have to have a heavy estate tax and their financial adviser puts them in high load one year buy bonds that they're going and hold for for one year the only way they can exist is by churning your portfolio they can make a bare living if they don't and they can make a good living if they do so you'd be a lot to have foundations which educate better the brokers of the land although that could be to it but to have them with respect to financial now I should feel grateful because a lot of the original sales of my textbook perhaps because of that personal finance or to chartered underwriter courses during this very long bull market period story of my life and that's part of the Lord's work I guess yes Larry personal finance is about the only advanced technology that every responsible citizen seems to have to master for himself her as you would helpfully add herself I don't need to know what makes a car go and just drive the car experts on engineering are there to make a car go do you see financial products or services emerging and if so what are they or policy changes emerging that would move personal finance more toward the car model where one car is about as good as another due to competition and individuals don't how you have as much of an opportunity to ruin their futures through bad decisions well there are lots of institutional changes and actual changes for example there is something intrinsically extremely sensible about annuities because we most of us know when we were born but the last thing we'll knows when we die and that uncertainty is something which can be insured but annuities have not been burglarized generally speaking have not been of the Vanguard type tiaa-cref in in some some degree there could be a lot a lot more of that and well if I know a lot more inventions I will just made them okay thank you very much

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Views: 11,324

Rating: 4.8974357 out of 5

Keywords: nobel, finance

Id: Cy6vstYFuig

Length: 38min 25sec (2305 seconds)

Published: Wed Mar 31 2010