Naomi - click here and write a clever title
Transcription of interview with Professor Daniel Kahaneman on January 3, 2011.
Douglas Goldstein, CFP®, Financial Planner & Investment Advisor
Professor Daniel Kahaneman is an Israeli-American psychologist and the 2002 Nobel Laureate notable
for his work on the psychology of judgment and decision making and behavioral economics
with Amos Tversky as well as others.
He established a cognitive basis for common human errors.
Currently, he is a professor at Emeritus of Psychology and Public Affairs at Princeton
University’s Woodrow Wilson School.
He is also a founding partner of the Greatest Good which is a business and philanthropy
consulting company.
He was born in Tel-Aviv in 1934 and spent his early childhood years in Paris where his
parents emigrated from Lithuania in early 1920s.
His family was in Paris when it was occupied by Nazi German in 1940.
His father was picked up in the first major round up of French Jews but was released after
six weeks due to the intervention of his employer and the family was on the run for the remainder
of the war.
Eventually, he and his family moved to British mandate for Palestine which was very soon
to become Israel in 1948.
Douglas Goldstein, financial planner & investment advisor, interviewed Kahaneman on Arutz Sheva
Radio.
Douglas Goldstein: Your interest began when you were in the Israeli army.
You had a project that you had to assess candidates for officer training.
You used an interesting test where a group of soldiers would have to lift a telephone
pole over a two and a half meter wall and dealing with the test, you claim the term
the “illusion of validity.”
Could you tell us what this is all about and where it came from and what it means?
Daniel Kahaneman: That’s not my invention.
It was conventional in the British army during World War II for selection of candidates for
officer school.
Illusion of validity is the sense of knowing that is unjustified and you really frequently
get it.
You get it when you interview people and you suddenly have the sense that you understand
their character and very frequently you just [don’t] so that’s the illusion of validity.
It’s quite common in our experience.
It’s of course not restricted to interview.
You get the same thing with financial analyst quite frequently.
You get this [biggest offense] of where things are going
really fast and we have no idea where things are going.
I don’t know if you agree simply with that study actually to an Israeli financial [subsidiary]
on the overconfidence of financial experts.
We see a prose of the major companies where we run a poll of CSOs every year and they
asked them what S&P 500 is going to do during the next 12 months and there are two observations.
One is they really have no idea, absolutely no idea in effects of slightly negatively
correlated with what happened in the market, but the second thing that tremendously we
were confident, that’s opposed to feed up an 18% confidence interval and only 33% of
the observations inside the confidence interval.
In other words, it supplies almost all the time.
If people told you what they really know, they should tell you where [inaudible 0:05:13]
S&P 500 would be somewhere between minus 10 and plus 30 next year.
It reverse things what you actually know.
They don’t know anything.
Douglas Goldstein: The problem is if you walk around and you don’t show any confidence
then no one is going to believe anything that you say.
Daniel Kahaneman: People actually take a look overconfident and some be rewarded for overconfidence.
It is also the case where people are not lying that is they really feel overconfident.
They can’t imagine the world going any other way than a particular way they imagine it
and because they can’t imagine an alternative, that confidence are what they see that can
help them.
We can’t imagine the future.
Douglas Goldstein: In order for people to act, don’t they have to be confident in
themselves and have confidence in their advisors?
Daniel Kahaneman: It’s a really good idea to have confidence in yourself as long as
it’s realistic, if you want to have completely unrealistic confidence in yourself that’s
to be able to do things about [feeling[.
Clearly, overconfidence justifies a lot of things that a lot of investors do.
Professionally, they were looking better but individuals who invest for themselves by enlarge
is money only and they don’t know it in advance and they do it because they are overconfident.
Douglas Goldstein: Do you find a difference between men and women in terms of overconfidence?
Daniel Kahaneman: Men are more overconfident than women which is why by enlarge, women
individual investors with individual brokerage account, women do better than men and significantly
[inaudible 0:07:19] and they do better than men because they do less.
They have fewer ideas that lead them to [offers] taken by another.
Men pay a lot more to investment cost than they act on many [moral] views.
In other words, they are overconfident.
Douglas Goldstein: Other research that you’ve done which has a groundbreaking effect is
what’s referred to as loss aversion.
You’ve demonstrated this in a study that showed the extraordinary reluctance to accept
risk that’s observed when people are offered to gamble on the toss of a coin.
They’re asked, “If we toss a coin and you could lose $20 if you lose the toss, how
much do you demand on the other side to win in order to play this game with me?”
You’ve found that people usually demand to get about twice the amount that they win.
What’s with the heart of this psychological peculiarity?
How can an investor get pass it so they can make rational decisions?
Daniel Kahaneman: It’s behind of something that is called “negativity bias” which
is in the process of receiving information in the brain sits priority over opportunities
and you see that everywhere in behavior with a various contrasting with a [inaudible 0:09:10]
to detect threats.
That manifests itself among other frames in loss aversion.
You just pay a lot more attention to lose within a game.
When you have a 50% chance to lose 20 then you’d want an equal chance to gain 40, that’s
about even to [inaudible 0:09:48] for people.
Douglas Goldstein: When you do that flip of a coin test, it’s a little more black and
white.
When people do this in their own investment portfolio, how does this play out?
Daniel Kahaneman: In the first place, this is in minority that is individual investors
and this is related for their willingness to take more risks from other people, but
when you talk to very wealthy advisors which is something that I have been doing our case
in the last three years, it turns out there are very loss of averse too but they wanted
to protect what they have.
They would like in addition to get a lot richer.
That’s why my objection is negative that is conservation of what they have so there
are very lots of rules.
When you want to discuss a policy that would be optimal for an individual, you need to
be conscious with loss aversion because if you’re not when something bad happens to
them, they want to change.
In the worst case, they want to change advisors but that will be very easy and they wanted
to turn their policy go to [bounce] and do something silly.
A lot of the mistakes that people make in investment are acting on loss aversion, acting
out their losses.
People are also highly optimistic in general so it is true that people who have loss aversion
tend to be more cautious than others but it is also true that they may not be cautious
enough because when they’re investing, if things are going well at the point in time
when they’re investing then like everybody else, they are fairly optimistic and at that
stage, they are willing to take more risk than later from learning because they don’t
know the odds of everything and then there’s pride.
The main integration of loss aversion for investing is that you have to think about
what you could sustain without changing your mind, without changing course and that is
an important role for the advisor undoubtedly is to anticipate the investor’s regret then
the investor might want to change his mind because if the investor would change his mind
and that’s bad for the investor and bad for the advisor.
Douglas Goldstein: How do you recommend that advisors present this to client?
The client comes in and said he’s got a half million dollars to invest.
“How risky is my portfolio?”
What’s the best way to say it to a person so he really can make a smart decision?
Daniel Kahaneman: In the first place, you probably would want to the financial advisor
not to speak about that half million to invest but to speak about the financial picture altogether
because he wanted to assume his portfolio to be balanced overall.
When you talk about half a million, the real question is how much loss you will be prepared
to sustain and still stick with the same policy.
If the person easily gets the impression that they would want to quit after relatively small
losses then they shouldn’t invest in risk and you should be much less to speak.
Douglas Goldstein: Can people really appreciate when you talk about dollars in terms of dollars
and the timeframe?
Daniel Kahaneman: The more you complete you make it, the better people think.
If you have a language that enable you to speak completely about the success at least
you could now say this is really [superior] because what you want to do is you want to
engage people in the exercise of predicting their future reactions and that is best done
by making it specific and complete as possible.
Douglas Goldstein, CFP®, is the director of Profile Investment Services and the host
of the Goldstein on Gelt radio show (Monday nights at 7:00 PM on www.israelnationalradio.com.
He is a licensed financial professional both in the U.S. and Israel.
Securities offered through Portfolio Resources Group, Inc., Member FINRA, SIPC, MSRB, NFA,
SIFMA.
Accounts carried by National Financial Services LLC.
Member NYSE/SIPC, a Fidelity Investments company.
His book Building Wealth in Israel is available in bookstores, on the web, or can be ordered
at: www.profile-financial.com (02) 624-2788 or (03) 524-0942.
Disclaimer: This document is a transcription and/or an educational article.
While it is believed to be current and accurate, divergence from the original is to be expected.
The original podcast can be heard at https://sites.google.com/site/goldsteinradioshows/.
All information on this website is purely information and should not be used as the
sole basis for making financial decisions.
The opinions rendered herein are those of the guests, and not necessarily those of Douglas
Goldstein, Profile Investment Services, Ltd., or Israel National News.
Readers should consult with a professional financial advisor before making any financial
decisions.
Please see the complete disclaimer at https://sites.google.com/site/goldsteinradioshows/.