Saturday, November 20, 2010

Book Review: The Flaw of Averages

Statistical uncertainties. A topic which the non-mathematician in me found rather daunting. As someone who prefers to do my own retirement planning and investment management, the reality is that I have to deal with a wide range of uncertainties on a daily basis. Getting away from that fact is not possible so I need to have at least some understanding of the basics.

Sam Savage's "The Flaw of Averages" was exactly what I needed to get my mind around some of the key issues. Written in terms that even a layperson can easily understand (and with plenty of humour), this book made for an educational and entertaining read.

Some key takeaways:

1. replacing uncertain future outcomes with a single average and then relying on that single average to plan for the future is a systemic error which explains why forecasts are always wrong (this is known as the "flaw of averages";

2. there is an important distinction between "risk" and "uncertainty" (uncertainty being an objective feature of the universe while risk is a more personal construct;

3. techniques for reducing uncertainty;

4. average inputs do not always deal produce average results;

5. the Seven Deadly Sins of Averaging (actually 12 of them);

6. some practical examples from the world of personal finance. Of these the most important is that a retirement portfolio which is adequate if a single average rate of return is achieved over the life of the portfolio is as likely to fail as to succeed.

Highly recommended for anyone with an interest in personal finance or investment management.

1 comment:

Laurent Franckx said...

I agree - the book is excellent, and should be read by anyone taking decisions in the case of uncertainty (everybody, basically).