What Behavioral Economics Taught Me About Watching The News

crispydoc Uncategorized 3 Comments

At the time of writing, I'm deep into Michael Lewis' latest book, The Undoing Project. It's a profile of the unlikely friendship and rich academic collaboration between two psychologists, Daniel Kahneman and Amos Tversky, whose interest in the systematic flaws of human decision-making gave rise to the field of behavioral economics.

A result cited from their studies felt particularly relevant given the recent cacophony from the financial media on the coming bear market.

The End Is Near - I Just Don't Know If I've Got Seconds Or Years Before It Arrives

Before exploring the telling example, let me be clear that I believe a bear is coming. But I don't know when, and neither does anyone else.

If the prospect of a bear market makes you nervous, what it's probably telling you is that your asset allocation is riskier than it ought to be. By all means, right size your portfolio risk to your actual tolerance.

Don't do it because you think you can time the market due to pessimistic news reports. Do it because you should have been taking less risk all along and this was the whack in the head you needed to realize it.

Wait, you insist, I'm just staying informed. It's not that I plan to act on this information, but I just want to have all the facts. That will help me make better decisions, right?

More Information Does Not Lead To Better Decisions

Kahneman and Tversky gave subjects probabilistic information about a pool of 100 people they were describing, informing them that 70 were lawyers and 30 were engineers.

When they asked the subjects to predict the odds that a single person from this pool would turn out to be a lawyer, the subjects appropriately replied that there was a 70% chance of being a lawyer.

Next, Kahneman and Tversky provided what Lewis calls a "hysterically bland" character description of a person also taken from this same pool:

Dick is a thirty year old man. He is married with no children. A man of high ability and high motivation, he promises to be quite successful in his field. He is well-liked by his colleagues.

After reading this description, comparable subjects were asked to estimate the likelihood that Dick was a lawyer. The subjects now estimated there was a 50% chance of being a lawyer.

Kahneman and Tversky concluded, "When no specific evidence is given, the prior probabilities are properly utilized; when worthless specific evidence is given, prior probabilities are ignored."

[As an interesting aside, I have read my share of evaluations and letters of recommendation from attending academic physicians supervising medical students, and I can easily imagine that Kahneman and Tversky lifted their hysterically bland, worthless specific character descriptions verbatim from some of these letters.]

Tune Out The Noise

The majority of finance media content is aptly described by the phrase "worthless, specific evidence." The evidence presented is intended to build a case for you to read their next article - not for you to make important financial decisions with long time horizons, like planning for your retirement.

Does this mean every expert is full of it? Of course not.

It means that when a brilliant person I respect says there will be bad times ahead, I don't get terribly fazed because my investing plan takes bad times and volatility into account.

Choose Your Inputs Carefully

I recently decided to reduce my social media time, and it's been liberating.

When I read, it's books that help me learn something new or appreciate contrarian thinkers who rock my intellectual world.

When I listen, it's to podcasts that broaden my world view or educate me, or to the soundtrack to the musical Hamilton so I can impress my children with mastery of lyrical hip hop when they least expect it.

And when the financial media starts to get intrusive and howls at me, I turn off the medium, smear on some sunscreen, sport a broad-brimmed hat (I come from flammable people) and take a nice, restorative hike.

At the risk of sounding like even more of a soy milk drinking Californian than I already am, I'll end with a favorite poem from Richard Brautigan that you can turn to when you feel stressed out by the financial media's nattering nabobs:

Karma Repair Kit Items 1-4.

1.Get enough food to eat,
and eat it.

2.Find a place to sleep where it is quiet,
and sleep there.

3.Reduce intellectual and emotional noise
until you arrive at the silence of yourself,
and listen to it.


Richard Brautigan

Comments 3

  1. Everyone needs to do the Karma repair kit.

    I have finished de-risking my portfolio this year because of my planned retirement within 5 years. Whether or not a recession happens in that time frame is anyone’s guess. If it doesn’t, I still am okay with not capturing all the gains I could have gotten because for me now it is important that I try and mute any of the potential losses.

    I hope you are coming to fincon 2020 because I would love to hear you bust some Hamilton lyrics on us

  2. The bear will come when the financial engineering no longer works. It works like an infection. It starts small it grows first slowly then more rapidly as the mass of infection explodes and eventually endotoxin clips the C end of the cascade proteins and the system collapses. The problem is we don’t know the extent and localization of the infection. A small local infection is a country specific recession, maybe Germany. A larger infection is 14 trillion in negative interest bonds and a faltering GDP on a rate of change basis.

    The last print was 1.9%. GDP has been under mean for many quarters implying a deceleration. Here are the last 4 years of average GDP ’16 1.525, ’17 2.425, ’18 0.875, ’19 2.025 or an average of 2.275 over the past 4 years The long term mean is around 3.4%. This data is calculated using FED data. This means in terms of long term averages we are contracting at 1.25%,( not expanding) on a rate of change basis. Yet all we hear are happy days are here again so buy STOCKS. You can get inflation with these kind of numbers, it’s called stagflation and is totally destructive of economies. Those are the data what is the narrative?

    What does Charles Payne and the boys with the pony tails and Crea-friggin-mer quack on TV between every my pillow commercial? I read a stat that long term, Creamer is right 32% of the time. This implies using a risk managed method of betting against Creamer would make you a billionaire. Beats hell out of passive investing (which is yet another narrative)

  3. I finished that last weekend thanks to your previous recommendation! I think the research they did was more fascinating than the book’s narrative (apart from the earlier chapters on their pre-academic lives which I really enjoyed).

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