• The AI act

    Artificial Intelligence (AI) is a family of technologies that can optimise existing processes and/or enable new activities, for example by improving predictive models or by personalising the delivery of services. It presents new opportunities, but also serious risks.

    In April 2021, The European Commission unveiled a new proposal for an EU regulatory framework on AI. The draft AI act is the first ever attempt to implement a horizontal regulation of AI. It is focused on the specific utilisation of AI systems and associated risks.

    The Commission proposes to establish a definition of AI systems in EU law and to lay down a classification for AI systems with a ‘risk-based approach’ in defining the different requirements and obligations.

    Some AI systems presenting ‘unacceptable’ risks would even be prohibited. ‘High-risk’ AI systems would be authorised, but subject to a set of requirements and obligations to gain access to the EU market. Those systems presenting only ‘limited risk’ would be subject to very light transparency obligations.

    While generally supporting the Commission’s proposal, stakeholders and experts call for several of amendments, including revising the definition of AI systems, broadening the list of prohibited AI systems, strengthening enforcement and redress mechanisms and ensuring proper democratic oversight of the design and implementation of EU AI regulation.

    In what relates the impacts of this act for the banking industry you can refer to ECB’s opinion on the AI Act.

  • ECB’s Opinion on the AI Act

    These are my notes on the ECB’s opinion on the Commission’s proposal laying down harmonised rules on artificial intelligence – Artificial Intelligence Act.

    This document sets the ECB’s view on the European Commission’s proposal on Artificial Intelligence and also lays down specific amendments and drafting proposals alongside those views.

    In this document, the ECB puts forward amendments aiming at clarifying the role it is supposed to play under the AI Act. It is pointed out that the ECB’s tasks should limited to the prudential supervision of credit institutions and not include the supervision of products for the purpose of ensuring consumer protection.

    The ECB suggests that AI systems intended to be used to evaluate the creditworthiness of individuals or establish their credit score that leverage on the standalone use of linear or logistic regression or decision trees under human supervision should not be classified as high-risk AI systems

    On the interaction between the AI Act and the CRD on the high-risk AI systems provided or used by credit institutions, the ECB stresses that because of the novelty and complexity of AI, and the high-level standards of the proposed regulation, further guidance is necessary to clarify supervisory expectations with regard to the obligations in relation to internal governance.

    The ECB also defends that the proposed regulation should be set out in sectoral regulation and supplemented by supervisory guidance. Therefore, the ECB calls for further clarifications regarding the applicable requirements and competent authorities with regard to outsourcing by credit institution users of high-risk AI systems.

    Finally, the ECB suggests that the entry into effect of requirements that relate to the qualification of AI systems intended to be used to evaluate the creditworthiness/credit score as ‘high-risk AI systems’ should be delayed until the adoption by the European Commission of common specifications on the matter

  • The Intelligent Investor, Mr. Market & Fluctuations (Chapter 8)

    The notes below refer to the Chapters 8 of The Intelligent Investor, covering the following topic: Mr. Market & Fluctuations. For an overview of the different sections of the book, refer to the following link: Introduction to the Intelligent Investor.

    Chapter 8 – Mr. Market & Fluctuations

    The stock market is prone to significant fluctuations. Investors often allow their emotions to affect buy and sell decisions. Many focus on timing the market (try to predict the market through direction, momentum, or various other indicators). Mr. Graham explains “it is absurd to think that the general public can ever make money out of market forecasts”.

    In The Intelligent Investor, Graham demonstrates that the investor should use pricing to make buy and sell decisions. One wants to buy stocks when they are priced below their fair value and sell stocks when they advance above fair value.

    If every investor did some research and only bought stocks below the intrinsic value of the company, the market would be efficient and fairly stable. But we know that this isn’t true, with the market swinging wildly over periods of euphoria and pessimism.

    Graham used a parable with an imaginary investor named Mr. Market to illustrate how an intelligent investor should take be indifferent to short term market fluctuations. This is a parable about greed and fear, price and value, and how the intelligent investor should (not) react.

    Be disciplined and don’t let your emotions convince you that Mr. Market’s prices are fair. On the commentary section, Zweig adds the template of contract you should sign (with yourself). I find it delicious. Give it a try:

    Key takeaways

    • Ignore short term price changes. Focus on the long term
    • Be disciplined. Don’t buy/sell because prices are high/low
  • Should you put all your savings into a MSCI World ETF?

    Investing all your savings in a MSCI World ETF is not a bad idea. But it might not be optimal, depending on your circumstances. MSCI World has yielded extraordinary returns in 2021 but it’s highly unlikely you will be able to get the same returns in 2022.

    How much money should you invest in the first place?

    It depends on your circumstances. There is not better and simpler guide to how much money you should invest than the 7 Baby Steps, by Ramsey. Prior to invest in ETFs make sure that, at least, you:

    1. paid off all your credits
    2. have 3-6 months of expenses in a savings account
    3. have taken advantage of all the tax-friendly retirement savings plans’ benefits available to you

    Use what you are left with to “build wealth and give” (7th baby step).

    Know your-self?

    What type of investor are you? Are you a conservative/passive or aggressive/active investor (see some consideration on this topic in the following post: Behavioral Finance and Investment Processes)? Most people should be passive investors. Making money being an aggressive/active investor is very difficult. It takes a lot of time and skill. Don’t overestimate your knowledge of the markets nor your willingness to take risks. Be aware of the most common behavioral biases in finance (see Behavioral Biases in Finance).

    Asset Allocation

    If you want to maximize returns and minimize risk you should invest both in stocks as well as in bonds. These assets’ returns are not perfectly positively correlated, meaning when your not making money in stocks, bonds might be performing just fine (or vice-versa).

    Stocks are typically riskier and provide higher returns than bonds. Therefore, the more risk averse you are, the more the portion of your assets should the invested in bonds. Typically the older you are the more risk averse you become. If you are young, you can afford to lose some money in the short term as you have many years ahead to recover from those losses.

    A simplistic to rule to determine how much you should invest in bonds and stocks consists of putting a percentage of savings into bonds that is equivalent to your age. For instance, if you are 43 years old you should invest 43% of your money in bonds and 57% in stocks.

    The total investable securities market

    Ideally you want to gain exposure to as many securities as you want (the more you diversify the better). If you want to do it yourself you can buy the most popular stocks and bonds ETFs that make the whole market. Keep in mind that in most cases, it requires a lot of ETFs to gain exposure to all of types investable securities in world:

    Large/mid cap stocksSmall/micro cap stocksInvestment grade bonds
    Developed countries46%8%22%
    Emerging markets18%3%3%

    Most people stick to the MSCI world index to get a diversified market exposure.

    The MSCI World index

    A MSCI world index only covers large/mid cap stocks in developed markets, roughly half (46% as per the table above) of the the total market of investable securities. Not bad for one single ETF, but you can better.

    What are you missing out by only investing the MSCI world:

    • Emerging market and small micro capitalization stocks which in the long term are expected to provide higher returns, despite the higher risks
    • Investment grade bonds, which have low risk (and returns) and provide diversification benefits
    • Other: non-investment grade bonds and frontier market securities in general (which make up less than 1% of of the market capitalization of investable securities worldwide)

    The question becomes, how to be exposed to the whole market, in a simple and cheap manner?

    A simple solution

    My recommendation would be to try to build your portfolio with following ETFs:

    • Vanguard LifeStrategy 20% Equity UCITS ETF EUR Acc
    • Vanguard LifeStrategy 40% Equity UCITS ETF EUR Acc
    • Vanguard LifeStrategy 60% Equity UCITS ETF EUR Acc
    • Vanguard LifeStrategy 80% Equity UCITS ETF EUR Acc

    The last ETF for instance (LifeStrategy 80%) invests 80% of the funds virtually in most of investable stocks, and the remaining 20% in almost all investable bonds.

    How to adapt Vanguard LifeStrategy ETFs to your risk profile?

    Let’s say you are 43 years old and you want to invest 60,000 euros. All you have to do is invest:

    • 85% in Vanguard LifeStrategy 60% Equity UCITS ETF EUR Acc; and
    • 15% in Vanguard LifeStrategy 40% Equity UCITS ETF EUR Acc

    This way you’d invest 57% (34,200 euros) in all investable stocks, and 43% (25,800 euros) in all investable bonds.

    This is the way to go if you want to maximise you return/risk ratio in an easy and cheap manner, keeping in mind your risk profile. This way you also avoid the recurrent rebalancing of your portfolio to keep the stock/bonds allocation you’ve set for your risk profile, which would imply spending a lot in trading fees and would have tax implications as well.

  • The Intelligent Investor, Investment, Speculation, Inflation, and Market History (Chapters 1, 2, & 3)

    The notes below refer to the Chapters 1, 2, & 3 of The Intelligent Investor, covering the following topics: Investment, Speculation, Inflation, and Market History. For an overview of the different sections of the book, refer to the following link: Introduction to the Intelligent Investor.

    Chapter 1 – Investment vs. Speculation

    One of the most important rules is to keep the activities of investment and speculation totally separate. They should be compartmentalized in your mind and kept in separate accounts. If you are to speculate, you should limit the allocation to these exposures below 10% of your portfolio.

    Graham recognizes that as there is intelligent investing, there is also intelligent speculation.

    • Intelligent Investing involves:
      • analysis of the fundamental soundness of a business;
      • a calculated plan to prevent a severe loss; and
      • the pursuit of a reasonable return.
    • Intelligent speculation involves:
      • basing decisions on the market price,
      • hoping that someone will pay more than you at a later date.

    Wall Street benefits from speculation because it produces money for the industry. Other investment approaches promoted by Wall Street includes stock picking “systems”. On this respect Graham points out that “all mechanical formulas for earning higher stock performance are a kind of self-destructive process – akin to the law of diminishing returns”.

    Chapter 2 – The Investor and Inflation

    Inflation must be a concern for investors because it lowers real wealth and purchasing power. Equity investments possibility redeem the lost purchasing power via dividends and capital gains. This does not mean there is a close connection between inflation and stock returns.

    There is never a perfect time to be in only one asset category (don’t put all your eggs into one basket). The intelligent investor must minimize risk by anticipating the unforeseen, being diversification is the foundation of such a strategy.

    In the commentary, Jason Zweig noted two relatively new “inflation fighters” investment options. REITs and Inflation-linked bonds provide some protection against inflation. Within a diversified portfolio, both of these may be appropriate for the intelligent investor worried about inflation.

    Chapter 3 – A Century of Stock Market History

    One should have a satisfactory understanding of stock market history. In order to analyze stock investments you must grasp the relationship between stock prices and their earnings, cash flow, and dividends.

    Zweig adds in the commentary that market fluctuations will be dependent upon real growth (increases of companies’ earnings and dividends), inflationary growth, and the amount of speculation (increase or decrease) the public is putting on stocks at the current moment.

    Nobel Prize Laureate Robert Shiller was inspired by Grahams valuation approach when he developed the Shiller PE ratio. The ratio compares the current S&P 500 index price to an inflation adjusted average of profits over the past 10 years. The higher the ratio the more overvalued the market is. For the evolution of the Shiller PE ratio over the past 150 years, refer to the following link: https://www.multpl.com/shiller-pe.

    Key takeaways:

    • Know the distinction between investing and speculating
    • Limit speculation to 10% of your portfolio
    • There is no strong correlation between stock returns and inflation
    • REITs and inflation-linked bonds can be used as “inflation fighters”
    • Market PE ratio well above the 20 average is indicative of overvaluation
    • Historical average real return of the market is 4%
  • The Intelligent Investor, by Benjamin Graham

    I’m an enthusiastic follower of Warren Buffett (and Charlie Munger his business partner). I often hear his investing lessons and more than once he has pointed to The Intelligent Investor book. In the book cover it even reads: “by far the best book on investing ever written”, Warren Buffett. I had it on my Goodreads ‘want to read’ list and someone offered it to me this Christmas. Buy now, I’ve already read the first 5 chapters (out of 20).

    Written by Benjamin Graham, the book was first published in 1949. Over the next decades, the book was subject to several updates, with the latest edition being published in 1973 (3 years before the author passed away). “Ben Graham (1894-1976), the father of value investing, has been an inspiration for many for many of today’s most successful business people. His most famous books include:

    • The Intelligent Investor
    • Security Analysis
    • The Interpretation of Financial Statements

    The most recent edition of the book includes commentary of Jason Zweig, a personal finance columnist for The Wall Street Journal. He is the author of Your Money and Your Brain (Simon & Schuster, 2007), one of the first books to explore the neuroscience of investing, and The Devil’s Financial Dictionary (PublicAffairs, 2015), a satirical glossary of Wall Street.

    Over the coming weeks, as I read the book I’ll be sharing some notes on the different chapters. You can find the list of chapters below (I will be adding links below as I make the posts):

    • Investment, Speculation, Inflation, and Market History (Chapters 1, 2, & 3)
    • The Defensive Investor (Chapters 4, 5, & 14)
    • The Enterprising Investor (Chapters 6, 7, & 15)
    • Mr. Market & Fluctuations (Chapter 8)
    • Investment Funds & Advisors (Chapters 9 & 10)
    • Investment Selection (Chapters 11, 12, & 13)
    • Comparisons & Thoughts on Value (Chapters 16, 17, 18, & 19)
    • Margin of Safety (Chapter 20)

    Once I’m done I will share my final thoughts.

  • Reading 2, The Behavioral Finance and Investment Processes

    Disclaimers: Below you can find my notes on the 2022 CFA Level 3 Reading 2. The original reading can be found on the CFA program curriculum. The original reading is credited to Michael M. Pompian, CFA, Colin McLean, MBA, FIA, FSIP, and Alistair Byrne, PhD, CFA. I am not a CFA Exam Preparation Provider. The content of this post hasn’t been reviewed by anyone other than me. This post alone might not be enough to give you a complete understanding of all the learning objectives of the reading for CFA exam.

    Learning outcomes:

    1. explain the uses and limitations of classifying investors into personality types;
    2. discuss how behavioral factors affect adviser-client interactions;
    3. discuss how behavioral factors influence portfolio construction;
    4. explain how behavioral finance can be applied to the process of portfolio construction;
    5. discuss how behavioral factors affect analyst forecasts and recommend remedial actions for analyst biases;
    6. discuss how behavioral factors affect investment committee decision making and recommend techniques for mitigating their effects;
    7. describe how behavioral biases of investors can lead to market characteristics that may not be explained by traditional finance.

    LOS 2a. explain the uses and limitations of classifying investors into personality types

    Psychographic classifications are particularly relevant regarding individual strategy and risk tolerance. One’s background, past experiences, and attitudes can play a significant role in decisions made during the asset allocation process. Although there are limitations to this type of analysis, gaining an understanding of one’s behavioral tendencies will likely result in better investment outcomes.

    Two models of investor psychographics from the 1980s are presented in this reading:

    • Barnewall Two-Way Model
    • Bailard, Biehl, and Kaiser Five-Way Model

    The Barnewall Two-Way Model, distinguishes two investor types: passive and active, while the Bailard, Biehl, and Kaiser Five-Way Model classifies investor personalities along two axes—level of confidence and method of action. In the reading one can find the characterization of the each of investor types for the two models.

    The reading than focuses on the developments of behavioral finance in recent years, concretely it touches on Pompian’s behavioral alpha “top-down” approach to bias identification, made of for 4 steps:

    1. Interview the client and identify active or passive traits and risk tolerance.
    2. Plot the investor on the active/passive and risk tolerance scale.
    3. Test for behavioral biases.
    4. Classify investor into a behavioral investor type, called
      • Passive Preserver
      • Friendly Follower
      • Independent Individualist
      • Active Accumulator

    Behavioral models to identify types of investors have limitations, such as the fact that individuals may exhibit both cognitive errors and emotional biases and/or characteristics of multiple investor types. Also, individuals can go through behavioral changes as they age. Additionally, because human behavior is so complex, individuals are likely to require unique treatment even if they are classified as the same investor. Finally, individuals can act irrationally at different times and without predictability.

    LOS 2b. discuss how behavioral factors affect adviser-client interactions

    Pompian (2006) outlines some fundamental characteristics that every successful client-advisor relationship share:

    • The adviser understands the client’s financial goals and characteristics
    • The adviser maintains a systematic (consistent) approach to advising the client
    • The adviser invests as the client expects
    • The relationship benefits both client and adviser

    Prior to drafting any asset allocation, tolerance questionnaires tend to be administered to clients. These have limitations. For instance, on top of ignoring behavioral issues, risk tolerance questionnaires can also generate different results when administered repeatedly to the same individual, but with slight variations (framing bias).

    LOS 2c. discuss how behavioral factors affect adviser-client interactions and LOS 2d. explain how behavioral finance can be applied to the process of portfolio construction

    There are several ways in behavioral factors can affect portfolio construction:

    • Inertia and default: not to change asset allocations through time, even though tolerance for risk and other circumstances might be changing
    • Naïve diversification: dividing contributions equally among available funds irrespective of the composition of the funds
    • Investing in the familiar: overweighting employer’s stock
    • Excessive trading, damaging returns
    • Home bias: overweighting investments in securities listed in their own country
    • Behavioral portfolio construction as opposed to mean-variance portfolio: portfolios being constructed layer by layer, with each layer being associated with a goal and being filed with securities that correspond to that goal, with covariance between assets being overlooked

    LOS 2e. discuss how behavioral factors affect analyst forecasts and recommend remedial actions for analyst biases

    Studies have shown that analysts persistently make forecasting errors arising from their behavioral biases. For example, people generally do a poor job of estimating probabilities but believe they do it well because they believe they are more informed and smarter than they are. This overconfidence type of behavior is sometimes referred to as the illusion of knowledge bias (see Reading 1, The Behavioral Biases of Individual). Overconfidence may be intensified when combined with self-attribution bias, which is bias is a bias in which people take credit for successes and assign responsibility for failures. Dealing with overconfidence is difficult, but prompt and accurate feedback combined with a structure that rewards accuracy can help analysts to re-evaluate their processes and self-calibrate.

    Company’s management can also influence analysts’ biases in conducting research. For example, a management presentation describing some specific successes or selecting favorable business performance indicators could anchor an analyst’s view of the business results as successful. Analysts can best cope with cognitive biases interpretating information by maintaining a disciplined and systematic approach.

    Confirmation bias, representativeness bias (see Reading 1, The Behavioral Biases of Individuals) and the gamblers’ fallacy, can also impact analysts in conducting research. The gamblers’ fallacy relates to wrongly projecting reversal to a long-term mean (Shefrin 2007).  Emotional biases are difficult to deal with. The solution is to collect information in a systematic way and use metrics and ratios that allow comparability.

    LOS 2f. discuss how behavioral factors affect investment committee decision making and recommend techniques for mitigating their effects

    Many investment decisions are made by groups or committees rather than by individuals acting alone. One should therefore be aware of the social proof bias, in which individuals are biased to follow the beliefs of a group. Teams that are diverse in skills, experience, and culture may be less prone to social proof bias.

    LOS 2g. describe how behavioral biases of investors can lead to market characteristics that may not be explained by traditional finance

    Research has documented several anomalies of market behavior that appear to contradict the efficient markets hypothesis. These anomalies consist of persistent abnormal returns that differ from zero and are predictable in direction. Examples of anomalies are:

    • momentum or trending effects, in which future price changes correlates with those of the recent past:
      • it is related to herding, which occurs when a group of investors trade on the same side of the market in the same securities regret-aversion bias
      • however, the disposition effect (it relates to the tendency of investors to sell assets that have increased in value, while keeping assets that have dropped in value) will encourage investors to hold on to losers, causing an inefficient and gradual adjustment to deterioration in fundamental value
    • bubbles and crashes
    • outperformance of value stocks relative to growth stocks over long periods of time, possibly due to a halo effect (tendency for positive impressions of a person, company, brand or product in one area to positively influence one’s opinion or feelings in other areas)

    In a nutshell:

    Despite its uses, there are many limitations of classifying investors into personality types, as these can’t grasp all behavioral nuances. Behavioural factors also influence adviser-client interactions, portfolio construction, analysts forecasts, investment committee decisions, etc. Some biases of investors can even lead to market anomalies.

  • Reading 1, The Behavioral Biases of Individuals

    Disclaimers: Below you can find my notes on the 2022 CFA Level 3 Reading 1. The original reading can be found on the CFA program curriculum. The original reading is credited to Michael M. Pompian, CFA. I am not a CFA Exam Preparation Provider. The content of this post hasn’t been reviewed by anyone other than me. This post alone might not be enough to give you a complete understanding of all the learning objectives of the reading for CFA exam.

    Learning outcomes:
    a) compare and contrast cognitive errors and emotional biases;
    b) discuss commonly recognized behavioral biases and their implications for financial decision making;
    c) identify and evaluate an individual’s behavioral biases.

    LOS 1a. compare and contrast cognitive errors and emotional biases

    The subject of behavioral finance can be classified as Behavioral Finance Micro (BFMI) and Behavioral Finance Macro (BFMA). BFMI examines the behavioral biases that distinguish individual investors from the rational decision makers of traditional finance. BFMA detects and describes market anomalies that distinguish markets from the efficient markets of traditional finance. In this reading, we focus on BFMI and the behavioral biases that individuals may exhibit when making financial decision.

    The simple categorization of distinguishing between biases based on faulty cognitive reasoning (cognitive errors) and those based on reasoning influenced by feelings or emotions (emotional biases) is used in this reading. Cognitive errors stem from basic statistical, information-processing, or memory errors and typically result from faulty reasoning while Emotional biases stem from impulse or intuition and tend to result from reasoning influenced by feelings.

    Cognitive errors are more easily corrected for because they stem from faulty reasoning rather than an emotional predisposition. Emotional biases are harder to correct for because they are based on feelings, which can be difficult to change.

    LOS b. discuss commonly recognized behavioral biases and their implications for financial decision making and LOS c. identify and evaluate an individual’s behavioral biases

    Cognitive errors

    1) Belief perseverance biases: tendency to stick to one’s previously held beliefs irrationally or illogically. Belief perseverance biases are closely related to the psychological concept of cognitive dissonance. Cognitive dissonance is the mental discomfort that occurs when new information conflicts with previously held beliefs or cognitions

    • Conservatism bias: belief perseverance bias in which people maintain their prior views or forecasts by inadequately incorporating new information.
    • Confirmation bias: tendency to look for and notice what confirms their beliefs, and to ignore or undervalue what contradicts their beliefs.
    • Representativeness bias: tendency to classify new information based on past experiences and classifications:
      – In base-rate neglect, the base rate or probability of the categorization is not adequately considered.
      – In sample-size neglect, Financial Market Participants incorrectly assume that small sample sizes are representative of populations.
    • Illusion of control bias: tendency of people to believe that they can control or influence outcomes when, in fact, they cannot.
    • Hindsight bias: bias in which people may see past events as having been predictable and reasonable to expect.

    2) Information processing biases: illogical or irrational information processing in financial decision making

    • Anchoring and adjustment bias: bias in which the use of a psychological heuristic influences the way people estimate probabilities.
    • Mental accounting bias: people treat one sum of money differently from another equal-sized sum based on which mental account the money is assigned to.
    • Framing bias: bias in which a person answers a question differently based on the way in which it is asked (framed).
    • Availability bias: bias in which people take a heuristic (sometimes called a rule of thumb or a mental shortcut) approach to estimating the probability of an outcome based on how easily the outcome comes to mind. Sources of availability bias include:
      Retrievability: If an answer or idea comes to mind more quickly than another answer or idea, the first answer or idea will likely be chosen as correct even if it is not the reality.
      Categorization: when solving problems, people gather information from what they perceive as relevant search sets.
      Narrow range of experience: this bias occurs when a person with a narrow range of experience uses too narrow a frame of reference based upon that experience when making an estimate.
      Resonance: people are often biased by how closely a situation parallels their own personal situation.

    Emotional biases:

    • Loss aversion: bias in which people tend to strongly prefer avoiding losses as opposed to achieving gains
    • Overconfidence bias: bias in which people demonstrate unwarranted faith in their own intuitive reasoning, judgments, and/or cognitive abilities
    • Self-control bias: bias in which people fail to act in pursuit of their long-term, overarching goals because of a lack of self-discipline
    • Status quo bias: bias in which people choose to do nothing instead of making a change.
    • Endowment bias: bias in which people value an asset more when they hold rights to it than then they do not.
    • Regret-aversion bias: bias in which people tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly.

    Understanding and detecting biases is the first step in overcoming the effect of biases on financial decisions. By understanding behavioral biases, financial market participants may be able to moderate or adapt to the biases and as a result improve upon economic outcomes.

    To adapt to a bias is to recognize and accept the bias and to adjust for the bias rather than to attempt to moderate the bias. To moderate a bias is to recognize the bias and to attempt to reduce or even eliminate the bias within the individual.

  • 2022 CFA Level 3

    The CFA journey

    For you to obtain the CFA charter you need to pass 3 exams (levels 1, 2, and 3). These exams are challenging, and you need to dedicate a lot of time to study the different learning objectives.

    The importance of each topic changes as you progress onto the different levels. For instance, currently, for the level 1 exam, the topic which is given the most weight is Ethical and Professional Standards (which is present across all levels).

    For the second exam (level 2), topics like Ethical and Professional Standards, Financial Statement Analysis (known in 2020 Curriculum as Financial Reporting and Analysis), Equity Investments, Fixed Income, and Portfolio Management and Wealth Planning are very important (each with a weight in the exam that can range from 10 to 15%).

    For the last exam (level 3) Portfolio Management and Wealth Planning is given a weight of 35-40%. None of the previous exams as such a deep focus on any of the other topics.

    The 2022 CFA Level 3 topics

    Here is a list of the topics covered by CFA Program Level 3 curriculum:

    • Economics (5-10%)
    • Derivatives (5-10%)
    • Fixed Income (15-20%)
    • Equity Investments (10-15%)
    • Alternative Investments (5-10%)
    • Portfolio Management (35-40%)
    • Ethical and Professional Standards (10-15%)

    Each topic is given a weight range which you can roughly extrapolate to come up with the possible number to questions you can be asked for each topic in the exam. For each topic there is number of study sessions (16 in total) made of several readings (35 in total). Each reading as a number of learning objectives. Questions in the exam are expected to be related to at least one of the learning objectives.

    Are all readings equally important?

    I tend to say no. Keep in mind that people who passed the Level 3 exam have spent on average almost 350 hours studying. If you have 35 readings you want to spend 10 hours on each, correct? No, in my opinion.

    Let’s assume actual weight given for each topic for exam seats somewhere in the middle of the ranges (as in the list above). If we regard every single topic as being equally difficult, the time we want to spend on each topic should be proportional to its weight. Now, the higher the number of readings per topic the less the time we should spend on each of them (remember the weight is given at the topic level, not at the reading level).

    Below you can find an estimate of the time I would try to spend on each reading (based on the topic weight and the number of readings per topic). According to these metrics, the 4 readings of Fixed Income seem to be the most important ones (as they could account for 17% of the questions), while the 3 readings on derivatives would be regarded as less important (as they could account for 7% of the questions). Therefore, you should put almost twice as much effort into the Fixed Income readings when compared to the Derivatives ones.

    TopicMid-weightBudgeted hoursReadingsHours per reading
    Fixed Income17%60415.0
    Equity Investments12%42410.5
    Alternative Investments7%25212.5
    Portfolio Management38%133158.9
    Ethical and Professional Standards12%4258.4
    Total (/average)100%3503510

    I usually don’t keep track of how much time I spend on each reading. But I do tend to make use of the table above (at the exercise level), specially in the weeks prior to the exams. Let me explain.

    I try to do the readings in order, starting with reading number 1 and finishing (in this case) with reading number 35. Initially, I take the time to read the CFA (or FRM) readings and do all the official exercises. At some point I realise I am wasting a lot of time, and I move onto the Exam Preparation Providers summaries (per reading) for the readings I haven’t covered yet. At the end I am left with a lot exercises to do (although I try to do a number of them each time I finish each reading). Once I’m done with readings, I move to the exercises. So, when I start to doing them, I aim at doing a number of exercises that is proportional to the weight of the topic on the exam. Each time I finish set of questions for given topic, I move to the topic in which I have the lower number of answers per budgeted hours (as per the table above). I don’t allow myself to move to a set of questions of another topic if I haven’t answered correctly to at least 70% of the questions of topic I am working on.

    What are the readings for the Level 3?

    Below you will find the list of readings for the 2022 level 3 exam. Each time I finish to study them, I will add a link to a post with some of my notes and takeaways. You might find them relevant to take a sniff at the content of different readings. But be careful, these notes are mine and haven’t been reviewed by anyone. On top, reading these notes alone won’t be enough for you to pass the exam. The best resources are always the CFA Institute ones, or those of certified Exam Preparation Providers.

    1. The Behavioral Biases of Individuals
    2. Behavioral Finance and Investment Processes
    3. Capital Market Expectations, Part I: Framework and Macro Considerations
  • My first post

    Why this blog?

    It is easy to forget things. It might be that someday someone ask me why I started this blog. Well, I am currently a Risk&Reg consultant at a Big4. I now have six years of work experience. Having devoted a lot of (scarce) free time to studying, I feel I have very few opportunities make use of the knowledge I gained on my Master, pursuing certifications like CFA and FRM, or just reading books.

    I just finished reading Rich Dad Poor Dad (by Robert Kiyosaki) and I am currently reading Think and Grow Rich (Napoleon Hill). These books have made me act. One doesn’t want to work forever. So by the means of this blog, I want to start to create something of my own, which someday I might able to monetize. For now, I will be creating content.

    What content?

    The name says it all. Finance, and Risk&Reg-related content. I’m studying Finance (will soon do the CFA Level 3 exam), so I’ll make a short post about each CFA reading, once I’m done with it. I work in the Risk&Reg department for a Big4 with banks operating in Europe, so I will make posts about Risk&Reg developments as well. I am reading personal development and investing books, so I might share with you some thoughts along the way. I frequently have people asking me questions about topics such as personal finance, so you might occasionally see some posts of that too.

    I want to make this blog about the Finance, Risk&Reg topics I come across. But I also want to make it about the feedback I get from the readers. Feel free to reach out in case you have comments about what I wrote or if there is a particular topic you would like me to touch upon.

    The next posts

    I am on vacations for the time-being, therefore I don’t to spend a lot of time writing on work-related topics.

    I am currently reading The Intelligent Investor (by Benjamin Graham, with commentary from Jason Zweig). According to Warren Buffet, this is “by far the best book on investing ever written”. I praise Warren Buffet a lot for his long investing career. There is no public appearance of him or his associate Charlie Munger that doesn’t appear on my YouTube feed. I wanted very much to read this book and I just got it as a Christmas gift! I will try to comment on each of the 20 chapters.

    Next to that I just registered for the August 2022 CFA Level 3. I suspect I will be spending a lot of time studying for it. I haven’t failed the first two exams and I don’t want to fail this one either. In the previous exams, to study I used mostly the CFA Institute and Exam Preparation Providers’ materials. In the days before the exams, I realized I could have been way much more comfortable for the Exam, had I made summaries on my own of the readings I was digesting. Making good summaries takes a lot of time, so does writing blog entries. Thus, I will re-use some of those notes and share them with you. It would be interesting to deep dive into topics I find interesting in each reading. Let’s see if I will be able to do that.

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