Wise Money Decisions

In an admittedly non-scientific study of the wealthiest 400 Americans, Forbes reports that a “significant percentage of them had parents with a high aptitude for math.”

“The ability to crunch numbers is typically a key to becoming a billionaire. Often, mathematical prowess is hereditary. Some of the most common professions among the parents of American billionaires for whom we could find that information were engineer, accountant and small-business owner.”

My dad has a graduate degree in math and taught college-level math. I won’t complain if the trend continues and I end up with a billion dollars.

Seriously, I never thought that math would make me rich. And it hasn’t yet, at least not enough to be part of the Forbes study (only a billion more and it will!).

But somehow I always knew it would open doors.

And it has. I was able to receive a graduate engineering degree from a good university because of math. I believe a big reason I was accepted into a good law school is because of math. I use math every day in my business and in countless other ways. 

I don’t know if it was nature or nurture. Probably a combination of the two. But I think it’s fair to say my love for math has affected my life more than anything other than the Three F’s, family, friends, and faith.

It’s important for all parents to help their kids develop a love for math. And if not a love, then at least a working knowledge and an appreciation.

They won’t become billionaires, but they will find more doors opened for them. They might not become rich, but they will avoid the anxiety that many people feel every time they are asked to do a math problem. They might not become a successful entrepreneur, but they will avoid the easy (and sometimes costly) mistakes made by the math illiterate.

This interview of Eugene Fama, who is commonly referred to as the father of the Efficient Market Hypothesis (”EMH”), was conducted in August 2009 by Dimensional Fund Advisors. 

A few highlights:

Responding to critics that the recent volatility has ”killed” the EMH: 

“The market can only know what’s knowable. It can’t resolve uncertainties that are unresolvable. So when there’s a large amount of economic uncertainty out there, there’s going to be a large amount of volatility in prices. As far as I’m concerned that’s exactly what we’d expect an efficient market to look like.”

Paraphrasing other interesting comments:

Most behavioral finance advocates like to point out inefficiencies, but usually conclude that it’s too impractical to take advantage of these inefficiencies and therefore you’re better off to do your risk-return tradeoff.  In other words they conclude that you’re better off to presume the EMH is an accurate description of the way markets work.

The top insiders do better trading on their own company’s stock but interestingly only by about 1%.

The most potent challenge to the EMH is evidence of momentum in stocks that can’t be easily explained. Secondly, movements due to earnings announcements tend to persist longer that expected.  Those are the two biggest challenges. Remember, EMH is a model, not truth. It’s a simplification of the world that does a good job on almost everything, but a few things it doesn’t do a good job on, e.g. insider trading, momentum, and movement from earnings announcement.

The EMH is not a perfect explanation of everything that happens in the market, but it is the best working proposition for use by investors.  Most investors should presume that the only way to reliably affect the expected return from their portfolio is by varying the level of risk they’re prepared to take.  Nothing in the last 12 months has altered that. Some people are claiming the market isn’t efficient, but they aren’t claiming there are easy profit opportunities out there.  It’s one or the other.

Whether you agree or disagree with Fama and EMH, this is a must-see interview in light of the recent volatility in the debate about EMH (ha ha).