The Problem of Financial Knowledge

Here's a better depiction of the Financial Knowledge stack I proposed last week after reading an article on Psychology today. Based on this diagram, I think I am better able to appreciate how much a person needs to know in order to put his financial house in order.

Let's first talk about the problem at each part :

a) We are not adequately trained at the theoretical level to address financial problems.

At the top-most layer of the FK stack, we have to deal with theoretical knowledge that comes from different disciplines. This can be diverse as the use of partial differential equations to derive the Black-Scholes model as well as legal knowledge on the structure of a business trust. This means that unless you spend years in school studying finance, you probably have holes in your knowledge to make financial decisions.

b) Market Knowledge is unwittingly outsourced to folks who do not have your best interests in mind.

At the middle layer is where the biggest problem are. The financial markets are so dynamic that teaching it in an academic environment would not be productive as the information would be worthless when you finally get out of school. Investment strategies come and go out of style, so even if somebody were to conduct studies on something, it may well be invalidated when there is a change in the position of the market cycle. It is also more profitable to keep some investing secrets to yourself.

Enter various entities in the finance and insurance industry. These institutions have the resources to fill the void - provided that the education you received would make you more susceptible to their marketing messages. This is why a lot of members in the investing public is stuck thinking that 3% returns is acceptable even when they may end up paying 3% in management fees.

[ You should note that, as a trainer, I mostly operate on this level too, but I get paid upfront to teach the material and no further commissions are made on trades. ]

c) Personal knowledge remains...well... personal.

In an ideal world, everybody making an investment decision would know their risk appetite and personality. However, people are often blind to their own biases even though the duty really falls upon them to know their personal circumstances and what they really want in an investment plan.

There is a lot of exploitation at this level as well. Sales professionals want to influence your propensity towards risk. A person who sells forex trading plans obviously want you to lean towards more risk-taking, the insurance salesperson wants to share plenty of horror stories to scare you into transferring your risks to the companies they are tied to.

Finally, the academic circles do not seem to have some sort of model to unify financial risk taking with standard academic models of personality. Even if this daunting task succeeds, some care needs to be taken to integrate the actual financial situation of a person for this to work properly. 

Right now financial institutions prefer to use "astrological signs" to determine what kind of investing style suits you best. One novel approach ( I joke about in private to other bloggers ) of late involves identifying what kind of animal you are to determine your investing personality.

d) Actionable Financial Knowledge is like Drilling for Oil.

The best analogy I can come up with right now is that acting on financial knowledge is like oil drilling.

We start out with some academic grounding in maths, accounting, economics and law when you are fresh from university. We also have some idea about what kind of risk appetite we have, how disciplined we can be and possibly what kind of life we want in order to feel satisfied with ourselves.

So the drill bit comes from the top and the oil resides at the bottom.

Unfortunately, most of us have to navigate through the rocks at the middle layer to reach the oil at the bottom. This means learning about the broad categories of assets we can buy, what kind of performance to expect, as well the risks of purchasing a security. Most importantly, how to get an account is opened and the kinds of orders we can issue to the stock market.

e) Financial Literature for Beginners

As I operate primary at the middle level, it is imperative that potential students of my class can have a reading list so as to benefit the most from my lessons.

For broad theoretical knowledge, I am glad to say that Wiley and Sons have recently launched The Conceptual Foundations of Investing. I have this on my Kindle but have yet to fully digest it so any feedback is welcome.

At the personal level, I have always recommended George Clason's The Richest Man in Babylon. It is motivating and lacks the MLM bullshit found in other popular finance books.

At the middle layers, there are multiple books covering the US markets but do not do an adequate job of covering our local stock-market. A Random Walk Down Wall-Street by Burton Malkiel and The Intelligent Investor by Benjamin Graham are useful references to cover this middle layer fo the FK stack.

( The fact that this layer is not covered adequately is the reason why I can operate as a financial trainer. This is also the reason why coaching someone financially is so lucrative. )