Charlie Munger has a unique way of describing the errors of our ways. These “errors” can be simply described as human nature.
And yet, overconfidence has a funny way of making people believe they’re immune to these errors. Somehow, they’re the exception to the rule.
In an article, Murger wrote about the perils overconfidence can have on something as simple as higher costs on average returns. This was in relation to foundations taking on more costly consultants for investment advice, but it’s certainly not limited to the professionals.
Everyone deals with these same issues in (and outside of) investing:
All the equity investors, in total, will surely bear a performance disadvantage per annum equal to the total croupiers’ costs they have jointly elected to bear. This is an inescapable fact of life. And it is also inescapable that exactly half of the investors will get a result below the median result after the croupiers’ take, which median result may well be somewhere between unexciting and lousy.
Human nature being what it is, most people assume away worries like those I raise. After all, in the 5th century B. C. Demosthenes noted that: “What a man wishes, he will believe.” And in self appraisals of prospects and talents it is the norm, as Demosthenes predicted, for people to be ridiculously overoptimistic. For instance, a careful survey in Sweden showed that 90 percent of automobile drivers considered themselves above average. And people who are successfully selling something, as investment counselors do, make Swedish drivers sound like depressives. Virtually every investment expert’s public assessment is that he is above average, no matter what is the evidence to the contrary.
“But,” some will say, “my foundation, at least, will be above average. It is well-endowed, hires the best, and considers all investment issues at length and with objective professionalism.” And to this I respond that an excess of what seems like professionalism will often hurt you horribly — precisely because the careful procedures themselves often lead to overconfidence in their outcome.
Similarly, the hedge fund known as “Long Term Capital Management” collapsed last fall through overconfidence in its highly leveraged methods, despite I.Q.’s of its principals that must have averaged 160. Smart people aren’t exempt from professional disasters from overconfidence. Often, they just run aground in the more difficult voyages they choose, relying on their selfappraisals that they have superior talents and methods.
It is, of course, irritating that extra care in thinking is not all good but actually introduces extra error. But most good things have undesired “side effects,” and thinking is no exception. The best defense is that of the best physicists, who systematically criticize themselves to an extreme degree, using a mindset described by Nobel laureate Richard Feynman as follows: “The first principle is that you must not fool yourself and you’re the easiest person to fool.”
- Saving Money and Running Backwards – M. Housel
- Ignoring Starting Yields: Nabbing This “Usual Suspect” in Poor Investment Outcomes – Research Affiliates
- Is Value Investing Dead? It Depends on How You Measure It – W. Gray
- What We Know About Financial Bubbles – J. Hilsenrath
- Unbridled – S. Godin
- The Dying Art of Disagreement – NY Times
- Art by Algorithm – Aeon
- The Massive Hedge Fund Betting on AI – Bloomberg
- Is AI Riding a One-Trick Pony? – MIT Tech Review
- The History of Sears Predicts Nearly Everything Amazon Is Doing – D. Thompson