Casinos thrive because people are wrong about the odds. The same can be said about investing. The reason why is what Daniel Kahneman calls the “single most important bias.”
The odds of most gambling games can figured out using grade school math. In a totally rational world, where everyone was out to maximize their money, nobody would play any game that favored the House. But not everyone plays for maximum wealth.
So there must be something else going on. Entertainment plays a part. The bells and flashing lights and the quick play bring thrills.
Really, some people think they’re the exception the odds. Ed Thorp calls gambling a tax on ignorance: “People often gamble because they think they can win, they’re lucky, they have hunches, that sort of thing, whereas, in fact, they’re going to be remorselessly ground down over time.”
Kahneman chalks it up to optimism combined with confidence. He explained how it fits in the context of investing during a 2005 interview: Continue Reading…