by Sam L. Savage
Reviewed by Jon Ford, CFP®
Jon Ford, CFP®, of CF Financial Planning Solutions Inc. in Mesa, Arizona, writes a regular "Financial Fundamentals" column for the Cedar Falls Times in Iowa.
The Flaw of Averages is interesting and fun to read. The intent "is to help you make better judgments involving uncertainty and risk, both when you have the leisure to deliberate and, more importantly, when you don't."
There are three sections to the book: foundations, applications, and probability management, totaling almost 50 chapters. The foundations section is provided so readers become more able to intuitively grasp and visualize the consequences of uncertainty and risk. The segment is peppered with many familiar cautions about the erroneous use of averages, correlations, standard deviations, and other statistical calculations.
The applications section reviews basic concepts in the development, use, and misuse of Modern Portfolio Theory, options, puts and calls, and derivatives. These, too, were familiar discussions with no surprises. The parts of this section related to supply chains and "hot button issues" (e.g. climate change, healthcare, and the war on terror) were interesting, but I'll leave it to others more familiar with these areas to decide if The Flaw of Averages adds understanding.
The book represents a very bright and creative effort intended to advance familiar fundamentals of statistical probability. It assumes the reader is slightly acquainted with probability and statistics (a college course or two), but casually dismisses the value of statistical models because they incompletely portray truth. The author's alternative is computer-powered spreadsheets.
The book sends the reader to www.flawofaverages.com for clarity and visual presentation of ideas. I didn't find this helpful but rather confusing. For instance, in the probability management section, readers are encouraged to go to an interactive Markowitz portfolio simulator on the website to illustrate "distribution strings" (aka, DISTs). (I'm still not sure what a DIST is, but it seems to be a bundle of data created, condensed, and standardized to allow for reliable replicates.) The illustration included in The Flaw of Averages differed from the website-frustrating and time-consuming. Although I use it daily, this may have been my lack of experience with some of Excel's functions.
It was difficult to decide for whom the book was written, but it's safe to say probably not for most financial planners. On the third or fourth reading and toward the end of the book, rightly or not, I concluded it was a personal journal of one trying to make sense of uncertainty in managerial operations research using newly developed spreadsheet and computer capabilities.
I enjoyed the journey and think you might too. Just don't look for applications beyond what you already should know if you manage portfolios. On the other hand, a quirky case was made suggesting we are more apt to die from suicide than a terrorist attack. If there's a lesson for financial planners it might be that the angst associated with market swings and political rhetoric may be more of a tragic threat to our clients than terrorist activity.
John Wiley & Sons, Inc. (2009)