Chaos is a friend of mine

Chaos is a friend of mineOver 50 years ago, Edward Lorenz created an algorithmic computer weather model at MIT to try to provide accurate weather forecasts. During the winter of 1961, as recounted by James Gleick in Chaos: Making a New Science, Professor Lorenz was running a series of weather simulations using his computer model when he decided to repeat one of them over a longer time period. To save time (the computer and the model were primitive by today’s standards) he started the new run in the middle, typing in numbers from the first run for the initial conditions, assuming that the model would provide the same results as the prior run and then go on from there. Instead, the two weather trajectories diverged on completely separate paths.

After ruling out computer error, Lorenz realized that he had not entered the initial conditions for the second run exactly. His computer stored numbers to an accuracy of six decimal places but printed the results to three decimal places to save space. Lorenz had entered the rounded-off numbers for his second run starting point. Astonishingly, this tiny discrepancy altered the end results dramatically.Lorenz

This finding (even using a highly simplified model and confirmed by further testing) allowed Lorenz to make the otherwise counterintuitive leap to the conclusion that highly complex systems are not ultimately predictable. This phenomenon (“sensitive dependence”) came to be called the “butterfly effect” because a butterfly flapping its wings in Brazil can set off a tornado in Texas. Lorenz built upon the work of late 19th century mathematician Henri Poincaré, who demonstrated that the movements of as few as three heavenly bodies are hopelessly complex to calculate, even though the underlying equations of motion seem simple.

Accordingly and at best, complex systems – from the weather to the markets – allow only for probabilistic forecasts with significant margins for error and often seemingly outlandish and hugely divergent potential outcomes. Continue reading

Ideological Through-and-Through

Homo economicus is a myth. This alleged “rational man” is as non-existent as the Loch Ness Monster, Bigfoot and (perhaps) moderate Republicans. Yet the idea that we’re essentially rational creatures is a very seductive myth, especially as and when we relate the concept to ourselves (few lose money preying on another’s ego). In fact, we tend to think that we’re almost superhuman in our ability to invoke reason to our advantage.

Think of Hamlet (Act II, scene 2), for example (with Sir Kenneth Branagh as the melancholy Dane in the clip below).

“What a piece of work is a man! How noble in reason! how infinite in faculty! in form, in moving, how express and admirable! in action how like an angel! in apprehension how like a god! the beauty of the world! the paragon of animals!”

Of course, there are some very good reasons to stand awestruck at what human reason can accomplish, particularly in the areas of science, technology and engineering. But you might also recall what became of Hamlet. We are much less rational than we assume. Continue reading

The Right Hedge for Retirement

res1114coverMy November column for Research magazine came in the mail today with the rest of a typically fine publication and went live on-line too. Here’s a taste.

The great fear of every retiree is running out of money. Guaranteed income via Social Security, defined benefit plan and annuity contract is by far the safest means to provide retirement income that one can’t outlive. Therefore, prospective retirees with insufficient Social Security and pension income would do well to consider the benefits of hedging their retirement investment risks via annuity contract.

One can readily and reasonably argue about how much guaranteed income a retiree ought to have, the extent of inflation protection that’s necessary and appropriate, how much one should pay for such protection, and how to balance the costs and tradeoffs (particularly relating to control and legacy) that annuities require. These issues require careful analysis and thoughtful consideration by prospective retirees, their families and their advisors.

But one cannot reasonably argue that annuities don’t do precisely what they are designed to do. They provide guaranteed retirement income that one cannot outlive. A retiree with more guaranteed income has less risk of financial disaster than one with less guaranteed income. Economists routinely sing the praises of annuities as does the federal government’s General Accountability Office. Guaranteed income offers retirees the great retirement hedge. Annuities do what they are supposed to do.

I hope you will read the full article as well as the entire magazine.

The Right Hedge for Retirement

Facts (and Minds) are Stubborn Things

When making his defense of some British soldiers during the Boston Massacre trials in December of 1770, John Adams (later the second President of the United States) offered a famous insight. “Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.”  Legal Papers of John Adams, 3:269. In a similar vein, Sen. Daniel Patrick Moynihan once said that “[e]veryone is entitled to his own opinion, but not to his own facts.”

I have often warned about our proclivity to and preference for stories to the exclusion of data (for example, here, here and here). Because stories are so powerful, we want the facts to be neatly packaged into a compelling narrative. Take a look at John Boswell‘s delightful send-up of this technique in the TED context below.


 We crave “wonder, insight [and] ideas.” Facts?  Not so much. Continue reading

When History and Finance Go Wrong

res1014coverMy October column for Research magazine is now available online. Here’s how it opens.

On a fine morning 100 summers ago in Sarajevo, an automobile driver ferrying the Austro-Hungarian Archduke Franz Ferdinand made a wrong turn off the main street into a narrow passageway and came to a stop directly in front of a teenaged activist member of the Serbian terrorist organization Black Hand. Gavrilo Princip drew his pistol and fired twice. The archduke and his wife fell dead. Within hours, World War I was well on its way to seeming inevitable (or at least necessary), all because of a wrong turn. And the idea that history is rational and sheds light on an intelligible story, much less a story of inevitable and inexorable advance, was also shot dead, as dead as the archduke himself.

I hope you’ll read it all.

When History and Finance Go Wrong