Is Personal Finance Science

8/7/2019 Is Personal Finance Science

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Is Personal Finance an Exact Science?

Recorded on 25 October 2006

Contributed by Boston University, Federal Reserve Bank of Boston,

and the Research Foundation of CFA Institute

www.cfawebcasts.org

Paul Anthony SamuelsonProfessor of Economics

Massachusetts Institute of Technology


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Presented by CFA Institutewww.cfawebcasts.org 2

Is Personal Finance a Science?

Personal finance is not an exactscience.


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The Beginning

Earliest political economy began as the

management of the household. I think. Therefore I am. Descartes

Because we humanoid primates had to

struggle with personal finance, we became

human. Joseph Schumpeter


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The Beginning

50,000 years ago, agriculture was the only

existent industry Farms were self sufficient

The introduction of the need for cash caused

personal finance to become market oriented


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Samuelsons Economics(1948)

Americas post-1935 social security system, which was

formulated in depression times to intentionallydiscourage saving and coax job-hoggers into

retirement. Of course, that will have to be abandoned in

the future as a pay-as-you-go non-actuarial financial

system. Such systems begin with seductively favorablepension rates that are transitional only, and must

mandate stiffer contributions in future stationary or

declining demographic states.


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Modigliani Lifecycle Finance

We begin with a free lunch

We used to think that retirement funds wouldcome partly from public funds

However, in retirement, we will need to be

supported by personal finance


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Lifecycle Retirement Mutual Funds

As an investor gets closer to retirement, the

retirement fund portfolio is automaticallyshifted to allegedly safer investments

nverity (or fallacy?)A 36-year horizon

portfolio endures half the stock risk of a 9-yearhorizon portfolio


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Good Sense

The Law of Large Numbers does not

vindicate the common sense (erroneous!)notions about risk erosion when investment

horizons grow from 1 to 10 or from 100 to

10,000 You will never correct by logic a mans error,

if that error did not get into his mind by logic.

Mark Twain


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Housing

Money aside, peoples homes are an ideal

contrivance for converting working-age savings

into retirement-age dissavings.


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Social Security

George Bush believes that we should be

allowed to transfer our share of money from thepublic social security fund into our own private

accounts, and that stocks will better augment

our retirement income.


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Good Sense

A century of economic history about private and

public financial markets strongly nominates thatone huge public, diversified, indexed socialsecurity fund, utilizing both stocks and bonds,and both domestic and foreign holdings, will

produce for the next generations betterretirement pensions. One of its unique virtuesis beneficial mutual insurance-reinsurance

among adjacent generations.


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Will Hedge Funds Make Our Golden

Years More Golden?

Or will the new concoctions of option engineers

result in microeconomic losses for pension

funds, and someday threaten the macro systemwith lethal financial implosions?


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Question:

Can we expect individuals to know enough

about what they are doing for their ownfinances?

Are we obliged to not allow them to have thatresponsibility, and somehow do it for them?


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Question:

Do you see new financial products, services, or

policy changes emerging that would movepersonal finance more toward the car model

(where options are fairly similar because of

competition, so people dont have as much ofan opportunity to make bad decisions)?

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Is Personal Finance Science