My views on the market, tech, and everything else

A Dozen Things I’ve Learned About Investing from Daniel Kahneman

1.            “Many individual investors lose consistently by trading, an achievement that a dart-throwing chimp could not match.” Leonard the Wonder Monkey will beat a muppet in an investing contest.  Not only will muppets lose to a dart throwing monkey, they will do worse than chance would dictate, especially after fees because of certain behavioral biases.


2.            “Few stock pickers, if any, have the skill needed to beat the market consistently, year after year.” The danger again is that “the many” will include themselves to be included within the scope of the word “few.” Kahneman puts it this way: “Everybody realizes that in principle, it’s impossible. But everybody personally thinks they can do it.” Kahneman points to Warren Buffett as one of “the few,” but even in that case Kahneman believes early luck and path dependence did a lot to make Buffett as successful as he is now.  The odds that you are similar to Buffett as an investor closely approach zero.  But that will not likely stop you from thinking so unfortunately.


3.            “I actually am a believer in index funds. … if you don’t have very specific information, which some say you’re not allowed to have, you better not kid yourself that you can pick individual stocks.” An investor who works very hard and is diligent can acquire information that is better than the market.  For example, there are professionals who have employees out in the field looking at how a given crop harvest is going. You are not one of those people, especially if you are at a baseball game. That your mobile phone allows you to trade options between innings is not relevant despite the advertising you may see on television.  


4.            “For a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker.”  Maubouissin has written the best book on this.  Mauboussin explains that there are some activities like hockey which involve more luck than others like basketball. Investing is actually quite similar. Mauboussin places investing closer to roulette than chess.


5.            “The persistence of individual differences is the measure by which we confirm the existence of skill.” and “Five years is really nothing. I mean, people who go by the record of five years just don’t understand statistics.” If you want to determine of an investor or firms has skill look at the persistence of outperformance.   There are firms like PitchBook which make a business out of providing this and other data to investors.  Investors who have great data and who consider it objectively outperform people who are guessing.  This should not be a surprise to anyone, but because people are inherently lazy (economy of effort) says Kahneman we ignore that fact and guess anyway.


6.            “Individual investors predictably flock to stocks in companies that are in the news.” Anchoring is a major dysfunctional bias.  Professionals are better in overcoming a bias like anchoring than individual investors but the difference is relative since both have the problem.  Kahneman points out: “People tend to assess the relative importance of issues by the ease with which they are retrieved from memory—and this is largely determined by the extent of coverage in the media.”


7.            “Groups tend to be more extreme than individuals.” When diversity of thought disappears within a group of people popular opinion can feed back on itself and bubbles can be created.


8.            “Many people now say they knew a financial crisis was coming, but they didn’t really. After a crisis we tell ourselves we understand why it happened and maintain the illusion that the world is understandable. In fact, we should accept the world is incomprehensible much of the time.” Josh Brown recently quoted Josh Friedman of Canyon Partners as saying: “You can protect against certain scenarios better than you can predict them. We don’t make macro bets, we try to protect against macro scenarios.”  It is not possible to predict the future in cases in which probability is unknown or future states are unknown.   This is why the concept of “margin of safety” makes so much sense.


9.            “We explain the past with the greatest of ease, and we’re really crummy at forecasting the future….” Barry Ritholtz writes and speaks eloquently about many things but this topic in specific he nails perfectly. Kahneman points out: “hindsight, the ability to explain the past, gives us the illusion that the world is understandable.”


10.          “Many people will admit that they made a mistake [putting money in dot-coms or telecoms at their peak] But that doesn’t mean that they’ve changed their mind about anything in particular. It doesn’t mean that they are now able to avoid that mistake.” Someone said to be once that he was glad he went through the dotcom bubble since he would know how to get out before it “popped” the next time. He was and still is wrong. What can you do? Kahneman’ ““Occasionally, when you think you might be making a mistake, slowing down and asking for advice might be a good idea.”


11.          “A person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise.” Regret is a highly dysfunctional emotion. Some people feel regret more than others and the more you feel regret the less well you will do an in investor.  Kahneman has said: my main advice to investors is know yourself, in terms of what you could regret. Because of what you might regret, if you’re regret-prone, there are certain things you just shouldn’t do.”


12.          People have “bounded self-control…. They have procrastination problems.” People don’t save enough money given their needs for things like retirement.  Researchers have actually located the part of the human brain which cases us to overvalue present moment consumption.  “Let us eat and drink; for tomorrow we shall die” is an attitude that causes a lot of financial problems.

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