"On Your Best Behavior" is a series of video vignettes covering the most important concepts in behavioral finance. In this episode, we learn why the future is actually more certain than the present in "Wall Street Bizarro World." Be sure and subscribe via YouTube to never miss an episode!
We live in a noisy world that is getting noisier every day. Faced with an onslaught of information that we are wired to misinterpret, we must develop simple strategies for making sense of it all. A few suggestions include:
Base Camp – Our imperfect memories and insensitivity to base rates means that we are likely to confuse ease of recall with probability. Wherever possible, seek out historical probabilities and rely on them as best guesses for your own course of action. If it takes most people two years to write a book, you’re unlikely to knock one out in three months. If most people should diversify because single stocks are risky – so should you.
Look for the Overlooked - Nassim Nicholas Taleb hilariously relates a story that speaks to how we think about innovation and how our best efforts to be creative can be thwarted by our tendency to overcomplicate things. As Taleb points out, the wheel was created over 6000 years ago, but the wheeled suitcase was not invented until 1970. In fact, humankind even achieved manned space flight (May 5, 1961) before the invention of the wheeled suitcase! Are there simple, elegant solutions that you are overlooking by trying too hard?
Keep it Simple - Just as more information about Linda the bank teller (look up this experiment if you're not familiar!) makes us less capable of judging what really mattered, so much of what passes as investment advice is marketing or clickbait with a thin educational veneer. A part of any sensible approach to security selection is determining what matters most and a focus on those variables to the exclusion of the cacophony all around. True investment signal consistently passes three tests – 1. It is common sensical (i.e., no Bangladeshi butter production) 2. It is research based 3. It endures as a result of a behavioural component.
Check Yourself – One type of information is deserving of extra scrutiny and an added dose of skepticism; information that you are excited to hear. Your excitement about believing something and your incredulity should be inversely proportional to one another.
If you’re now convinced of the need for greater humility in your investment approach, a natural next question is, “Where do I start?” The journey toward admitting ignorance and culpability is winding and difficult but has both financial and relational rewards. Here are a few places to start:
Man of steel – You’ve likely heard of a “straw man” argument in which a weakened caricature of an opposing opinion is presented, only to be dismantled. A less discussed but more effective critical thinking technique is to create a “steel man”, which represents the very best thinking and most rigorous empirical proof of an opinion with which you disagree. Rather than using the straw man as a rhetorical punching bag to feed your ego, build a steel man that will sharpen your thinking, cause to you to look in dark corners and consider new vantages.
Love the questions – In Letters to a Young Poet, Rainer Maria Rilke writes to his protégé: “I want to beg you, as much as I can, dear sir, to be patient toward all that is unsolved in your heart and to try to love the questions themselves like locked rooms and like books that are written in a very foreign tongue. Do not now seek the answers, which cannot be given you because you would not be able to live them. And the point is, to live everything. Live the questions now. Perhaps you will then gradually, without noticing it, live along some distant day into the answer.” Western culture is in love with certainty and bravado but the uncertainty of markets necessitates that we pursue a dynamic approach that is rooted in a fascination with the process rather than looking for silver bullets. The paradoxical truth is that only by learning to love the questions will we ever find the answers.
Take Your Time – For years scientists have puzzled at the evolutionary reason for depression. Species tend not to adapt in ways that are self-harming and yet depression on its face does very little good and a whole lot of harm to the organisms it touches. But more recent research shows that deep sadness may have a strong evolutionary purpose that is rooted in the depressive tendency to ruminate on problems. By playing and replaying a negative event over and over in our minds, we often arrive at solutions that can be called upon at a future date. What hurts in the moment may be profoundly beneficial down the road. As Warren Buffett has pointed out, there are no called strikes in investing; all the time pressure we may feel is arbitrary and self-imposed. We would do well to follow the admonition of John Dewey in How We Think, - “To be genuinely thoughtful, we must be willing to sustain and protract that state of doubt which is the stimulus to thorough enquiry, so as not to accept an idea or make a positive assertion of a belief, until justifying reasons have been found.”
Take the outside view – When making a decision we tend to rely on what social scientists call the “inside view.” The inside view is our perception of a decision as informed by our own biases, anecdotal experience and a convenience sample of whatever data pops to mind first. Conversely, taking the “outside view” means a more dispassionate appraisal that depends more on base rates, probability and facts than convenience and personal experience. In Think Twice, Michael Mauboussin sets forth four steps to taking an outside view of a problem. They are:
1. Select a reference class – compare your problem to other problems like it
2. Assess the distribution of outcomes – examine rates of success and failure
3. Estimate probabilities – based on the external evidence, estimate timelines, failure rates and obstacles to success
4. Fine tune your prediction – let bumps in the road and changing circumstances alter your estimate accordingly
By relying on external data, you are likely to arrive at a much more realistic picture than by leaning on your personal experience. If it takes most people two years to complete a task, you are unlikely to finish yours in six months. The outside view is an effective way of combatting ego risk by reminding you that you’re not that great.
Those who can, teach – A quick question for you, gentle reader, “Do you know how a toilet works?” On a scale from 1 to 10, how familiar would you say you are with the workings of a toilet? Go ahead and answer. Now, explain to me in detail the mechanics of a toilet, I’ll wait. Done? Ok, now let me ask again – on a scale of 1 to 10, how well do you understand the workings of a toilet? Research by Steven Sloman of Brown and Philip Fernbach at the University of Colorado shows that having to teach a concept has a humbling effect that brings our beliefs more in line with our actual understanding. The pair have used this technique to moderate beliefs about everything from single payer healthcare to, well, toilets and have found that, “As a rule, strong feelings about issues do not emerge from deep understanding.” The next time you feel as though you must buy or sell a security, take a moment to explain, in detail, the factual reasons why this is so. You’re likely to find that your enthusiasm has gotten the best of your brain and nothing brings them back into sync like having to teach.
This week on the podcast we tackle the evidence for and against willpower and free will and discuss the following:
- Would you have helped Anne Frank if you had been alive during Nazi occupation?
- Why do people who drive Audis make such poor spouses?
- What causes willpower to be depleted?
- What should our understanding of the limits of willpower mean for the way that we manage money?
To listen to this latest edition of the Money, Mind and Meaning Podcast please click HERE and don't forget to rate, review and share to help us spread the word. Thank you!
One of the strange paradoxes of human psychology is that our tendency to be overconfident has both helpful and harmful aspects. After all, starting a restaurant or a small business both have low odds of success, but we are awfully glad that overconfident dreamers do it anyway! But while overconfidence may help us get out of the bed in the morning or encourage us to embark on an entrepreneurial journey, its impact on investment decisions is unfailingly negative. Today on the podcast, tune in to hear five concrete ways to beat overconfidence en route to having a more fulfilling life.
Listen HERE or on Apple Podcasts.
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