I always enjoy the thoughts of Daniel Kahneman even if I don’t entirely agree with everything he says. Then again, I might just be one of those quacks he refers to who has convinced himself that he’s an expert in something that no one is really an expert in….
Forbes: You won a Nobel Prize for fathoming the human mind. You’ve made the point that perhaps because there are so many smart people in finance, that individual stock pickers, managers, cannot consistently beat the market.
Kahneman: Well, it’s not a point I made. The point, I’m not a finance expert, so you know.
Forbes: Well, clearly, they’re not either.
Kahneman: Well, when it comes to stock picking perhaps nobody is. That certainly was [Burton] Malkiel’s (PH) point. So, I am the consumer of this stuff. But what I find very interesting is that although everybody, I think, recognizes that in principle, you can’t do this. Because if you could pick stocks very well, then other people would also be picking those stocks, so the advantage would be gone. So everybody realizes that in principle, it’s impossible. But everybody personally thinks they can do it.
Kahneman: Yeah. And that’s exactly like the officer story. That, I find fascinating. I call it an illusion of skill. You know that it’s wrong, but you feel something else.
Forbes: And why does that persist?
Kahneman: It persists because you get the immediate feeling that you understand something. That is much more compelling than the knowledge of statistics that tell you that you don’t know anything. And, that again, is the officer story. But it’s writ large, that you really see it at work in many domains. In the financial domain, where people feel that they can do things that, in fact, we know and they should know they can’t do.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.