Stan's World - A Legend Passes

Stanley F. Ehrlich |
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Financial planning

Daniel Kahneman died on March 27th. Professor Kahneman was a “pioneer of what became known as behavioral economics.” If you’ve never heard of him, you may be surprised to learn the portfolio you own was partially inspired by his research and writings.

I had the good fortune to hear Professor Kahneman deliver a keynote address while I attended a financial planning conference. His logic was impeccable: “Why do we sell our winners too soon and hang onto our losers too long? Why don’t we realize that most hot streaks are just luck? Why do we say we have a high tolerance for risk and then suffer the torments of the damned when the market fails? Why do we ignore the odds when we know they’re stacked against us?”1

Kahneman noted that “money lost isn’t the same as money gained. Losses feel at least twice as painful as gains feel pleasant.” At the lecture I attended, he asked the audience how many would bet $100 on a coin toss? In order to get bettors, an overwhelming majority of the attendees (all of whom were financial planners) wanted more than $100 to take the bet. 

According to Kahneman’s research: “We think short streaks in a random process enable us to predict what comes next. We think jackpots happen more often than they do, making us overconfident. We think disasters are more common than they are, making us suckers for schemes that purport to protect us.”

Kahneman’s work ranged beyond investing. Before making important decisions in any field, Kahneman said you should first understand the base rate.

“If you’re thinking of starting a business, your gut may tell you there’s no way you can fail. According to the Bureau of Labor Statistics, however, half of new businesses die within the first five years. That base rate comes from millions of startups, each of which also expected to succeed. You, on the other hand, are a sample of one.

“Knowing that the base rate is 50/50 shouldn’t deter you from trying, but it should prevent you from being unrealistically optimistic.” 

Kahneman was raised in France during World War II. Being Jewish, he spent years of his youth hiding from the Nazis in barns and chicken coops. Perhaps that’s where his problem-solving skills emanated, though he insisted that wasn’t their origin.

“For all his knowledge of how foolish investors can be, (Kahneman) didn’t try to outsmart the market. ‘I don’t try to be clever at all… The idea that I could see what no one else can is an illusion.’ Thus, most of his money was in index funds. Added Kahneman: “All of us would be better investors…if we just made fewer decisions.”

If you’re looking for a book that can influence your thinking and decision-making for the rest of your life, get a copy of ‘Thinking, Fast and Slow,’ by Daniel Kahneman. It’s a fascinating exploration of the mind.

 

1 Zweig, Jason. “The Psychologist Who Turned the Investing World on Its Head.” The Wall Street Journal, 29 Mar. 2024.

 

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