Thursday, February 20, 2020

Which type of Charlatan are you ?

Image result for ben carlson scam book

I strongly recommend Ben Carlson's Don't Fall For It for any reader who is trying to become more streetwise. More importantly, as someone who aspires to disrupt the training industry, it is important for me to be armed with a better way to distinguish between a crook and the real deal in my own industry and, as it turns out, one of the chapters from the book makes the price of of the book worth paying for.

Basically, there are two kinds of Charlatans, each corresponding to one form of statistical error.

a) Type 1 Charlatan

A type I error in statistics is a false positive. If you are shopping and get a fire alarm but there is no fire, you get a false positive. Correspondingly a type I charlatan is someone who is sincere about what he is doing, but following this charlatan ultimately destroys you. The example in the book is John Law, a Scottish economist who convinced the French government to develop the use of paper money and ultimately precipitated the Mississippi Bubble which led to massive losses for French citizens and led to his dismissal in 1720.

b) Type II Charlatan

A type II error in statistics is a false negative. It is the situation where there is indeed a fire but it was not detected by a fire alarm. Correspondingly, a type II charlatan is someone who knows that he is a fraud and goes ahead to cheat other people with the aim of becoming really rich. John Blunt, who was the founding director of the South Sea Company, did something similar to John law and was responsible for the South Sea Bubble that affected many hapless English investors, is an example of such a person.

If we contextualize the situation to Singapore, this framework may be useful in daily life :

I think the first application is on any financial adviser that you may have. There will be a class of FAs who are doing this work to churn commissions. Those that fall into Type II category may be the kind of folks who openly refuse to sell you term insurance or find all sorts of ways to churn the current policies that you have. My commissioned-based agent friend, before quitting, used to tell me stories of their agency bosses who spent a lot on a lavish lifestyle. An agent friend, prior to leaving the agency, told me his boss even flew into a rage when he publicly challenged his lavish spending ways in some company meeting.

( But I think he had fun asking why his soon-to-be ex boss why she was not setting a good example. )

In my opinion, the Type II FAs are actually the safer ones - once you know someone who just wants to earn commissions, you can do your own research and just buy what you need. As practice, I think there are enough groups in the Web that act as a zoo for Type II FAs - just observe how aggressively they defend the high-commission ILP products online.

The real danger are the Type I FAs - The sincere folks who are not really numerically savvy who really believe that some products are great until they explode in your face. Type I FAs can sell a lot of products and ruin a lot of lives. There is very little defense against someone who is genuine about helping you. The only way I can think is to flip the table and educate the FA on how insurance products are structured on the back-end. One possible approach is to get them to befriend an actuary and say that you'll buy something if the actuary buys it for himself.

I would avoid eating sausages that the sausage maker would, himself, refuse to eat.

Of course for any discussion to be fair, the framework has to apply to investment trainers as well. Generally speaking, a trainer is more likely to be Type II if :

  • Employs fake credentials. Without mentioning actual names, there is case law on such trainers in Singapore.
  • Cherry picks investment results. For results to be credible a consolidated snap-shot of the entire portfolio should be made available. If you just share your 10x baggers, what about the bad investment calls you have made ?
  • Demonstrates best effort to employ empirical findings to back all assertions. 

This leaves folks in a conundrum. What about the Type I investment trainer ? Someone who is earnest about his training program but we have no idea whether his approach can lead to ruin.

Because finance is a wicked problem, it is entirely possible for someone sincere to product horrible investment results. Heck, even someone with the right methodology can lead to horrible results.

In this matter even my suggestions are somehow incomplete and need further refinement :

  • The trainer should be open-minded to accept that there are plenty of alternatives to make money. 
  • There is an adherence to the doctrine of falsifiability - Every model can potentially be disproved by investment results. This can lead to new, improved model over time.
  • The trainer must be intellectually humble enough to flag out all bad judgment calls and find ways to turn them into teachable moments.

The Type I or Type II Charlatan is a great framework for assessing any scheme you encounter. The first thing you do is to assess whether you might be subject to a con from someone who is out to get something from you. Next you need to accept the reality that even if the person is sincere, the scheme in question may still be unsafe for you to act.

Nevertheless, if you can, read this book.

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