Kahneman’s latest book, Thinking, Fast and Slow, is a must read for anyone interested in how people make decisions. The key takeaway from the book is that there are two different systems that work in parallel. The fast system is based on emotional brain processing and the slower system is based on reasoning. Most of Kahneman’s academic research revolves around how decision making gets corrupted by biases of the fast system. For example, the fast system is biased to believe statements while the slow system can be more cynical. When one is in a happy mood, the slow system, which consumes a fair amount of resources (oxygen, glucose, etc.), puts its guard down and you rely more on the fast system. This is why you are more likely to believe a lie when you are in a happy mood and why you tend to be more cynical when you are sad. As a professional investor, I can relate to this. I find that I am more likely to take risks when I am in a good mood and become more risk-averse when I am in bad mood. While most of Kahneman’s own research revolves around how “fast thinking” causes people to make mistakes, he does recognize that the fast system can actually be better for some situations. For example, chess masters can intuitively and quickly make very good logical decisions. They do not have to slowly evaluate a number of options. Rather, by recognize patterns, they can quickly come up with solutions to chess problems using the fast system. Firefighters and soldiers may also be better off making split second decisions based on what their gut instincts are telling them.
I humbly disagree with Kahneman, a Nobel laureate, and some other prominent psychologists when it comes to “fast-thinking” and investing. They argue that the stock market is too complex and random for intuition to be developed. They believe that the randomness causes people to build incorrect association biases. This argument is flawed. While the overall market may seem complex and random, there are many patterns within it that recur frequently. The best money managers recognize patterns developing ahead of most. They also can develop useful intuition because they are honest with themselves about the role luck had in their success. The intuitive decision-making that is involved with investing is much more complicated than other types of decision-making. However, that does not mean that we should abandon trying to better develop and use gut instincts when we invest. Some psychologists, like Gary Klein, also cite the fact that a large percentage of mutual funds underperform market indices every year. To them, this is proof that intuition built from investing experience does not translate into better decision-making. While it is true that most mutual funds underperform, a small percentage outperform consistently, which suggests to me that there is a handful of investors that have a “secret sauce.” Moreover, the fact that many of the statistically best investors seem to come from places where they had similar training (i.e., disciples of Benjamin Graham, Julian Robertson, etc.) implies that the “secret sauce” can be learned.
If you liked this post, check out my book: The Emotionally Intelligent Investor: How Self-Awareness, Empathy and Intuition Drive Performance.
Yea, how can they explain the success of all the Tiger cubs (Julian Robertson progeny) and Buffett value family. No way that’s random. Tiger Global, Blue Ridge, Bridger, Shumway, Lone Pine… the performance results speak for themselves.
Wonderful article. I always saw a Conman as sort of cowardly proponent of the analytic, always glorifying the value of linear thought, and the function of short-term memory – receiving praises only from a public with an already inflated sense of intellectual worth (IQ theory). It remains so, the greatest philosophers of mind have always supported intuition and the freedom in selecting elements of thought (Von Neumann called it art), while the public will cower behind analysis, as if it somehow makes up for their lack of worldly achievements.