Nobel winner Daniel Kahneman’s new book on bad decisions has a lot to say about market overconfidence and money mistakes

Nobel Prize-winning psychologist and economist Daniel Kahneman has a new post out asking a question that is central to making the right calls on the markets and money: Why does everyone make such bad resolutions and what can we do about it?

“Noise” was co-written with Olivier Sibony, a French expert in decision making, and Cass R. Sunstein, a sound scholar and behavioral economics expert. Kahneman is one of the founding fathers of behavioral science and author of the seminal work, “Thought Fast and Slow.”

My review of the book is here:   

I sat down with Dr. Brad Klontz, a member of the CNBC Financial Wellness Cabinet to get his reaction to Kahneman’s central thesis, which is that biases and noise (random variability in our judgments) are ever-present in our contemporaries, but there are ways we can improve our judgment skills. Dr. Klontz is a CFP and psychologist and author of several books, including most recently, “Boodle Mammoth” (Wiley, 2020).

CNBC: The central thesis of the book is that people — particularly professionals like doctors, mediates, and financial advisors — often make very bad judgments. Radiologists don’t provide consistent interpretations of X-rays. Judges don’t provender consistent judgments. Financial advisors are overconfident in their advice. Do you concur?

Klontz: Yes.  Being an expert in a particular forte can make biases more difficult to identify, more resistant to change, and lead to greater harm.

CNBC: Kahneman indicates there are problems with “bias,” where people are consistently weighted toward one viewpoint, like a bathroom graduation that is always two pounds over. But his emphasis is on “noise” which he calls “random variability in judgments,” where the decision-making is unspecific and inconsistent.  Why does that happen?

Klontz: Partly it’s a problem that people don’t recognize the random nature of their determination making. But there’s other reasons. While it can backfire, ironically, variability in judgment has been one of the keys to our survival as a species. Multifarious decisions are not black and white. In primitive times and today, people could die from a bad judgment, so there is a bit of natural pick in there.

This problem is well-known in the field of psychology. For example, random error exists in all attempts to measure devices, such as personality traits or the effectiveness of medications or therapies. We use the scientific method and statistical analysis to try to mitigate random blunder, but it is always a threat to our trying to make sense of objective truth. 

CNBC: Kahneman recommends several ways to dispute bad decision making and noise. He talks about “decision hygiene” or ways of making more consistent judgments. Does that pressure sense?

Klontz: Yes. I love the concept of delaying intuition, of not immediately acting on your instincts. Open-mindedness is associated with good fortune in almost all endeavors. Don’t trust your instincts. In my last book “Money Mammoth” I talked a lot about the “tribal discernment,” what is the optimal way to deal with life in a group of about 150 people, which is how our ancestors lived. It labourers explain why we should mistrust our instincts when it comes to money, because the exact same instincts that succoured us survive and thrive in small groups with constant threat often backfire in our modern financial lives. In indispensable, when it comes to money we are wired to do it all wrong. 

For example, herd instinct is material when you are in a primitive society.  If everyone is running from a lion, you should too. If you decide to not go along with the herd and are fixed still, you are going to get eaten. Everyone who believed you should stand still while everyone else is running has caused picked off, and they didn’t pass down their genes to us. 

While it helped us survive throughout all of prehistory, the common herd instinct is bad when you are making modern financial decisions. When everyone is getting into cryptocurrency, we are hard-wired to think that we should join them. On a deep psychological level, it feels like a threat to our survival to not jump in. So we hold to keep second guessing and combatting our natural instincts. Always second guess yourself, avoid overconfidence, and prevention open-minded.

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CNBC: So we should have less confidence in our instincts?

Klontz: We would transform our world if we had skimpy confidence in our conclusions. We are constantly segregating ourselves and surrounding ourselves with people who think like we do. Sometimes our faiths are so strong we try to hurt people who believe differently. We need to be able to observe ourselves more objectively. 

Less reliance would reduce conflict because we’re not as entrenched in our subjective conclusions.

Putting some time between our impulses and proceedings helps calm down our emotional brain and helps us activate our prefrontal cortex — the part of our brain that supporters us think through the consequences of our actions. It can also give us time to seek out the opinions of others too. 

CNBC: Kahneman also seconds that organizations do “noise audits” where they check to see how consistent the judgment-making is among their group, whether it is radiologists, deems, or stock pickers. Your reaction?

Klontz: It’s a great idea, and the only surprising thing is it’s not done on a regular principle. This is well-known in psychology. It’s called inter-rater reliability, which acknowledges that it can be difficult for even experts to tally on their analysis and conclusions. For example, in diagnosing an autism spectrum disorder, the gold standard focuses on training to safeguard inter-rating reliability to make sure everyone is coming to the same conclusion. And I absolutely agree it should be done somewhere else. We should put much more work into taking established methodology in psychology and generalizing it across professions, mainly those that are involve life and death decisions, like medicine or law. 

CNBC: Kahneman recommends more rigorous use of rules-based firmness making to get away from random human judgments. Do you agree?

Klontz: Yes, particularly when there is a clear clues of a correct or incorrect decision, such as this person has a tumor or they don’t. When there are clear life or finish decisions, we need to limit variability in judgment. I mentioned the autism diagnosis. That is where you need a structured, credible, rules-based approach. 

But we can’t become too rigid or rule-bound and need to keep an open mind. We have to recognize that there will be fluctuates in the rules as our knowledge base increases and be open to changing those rules when the facts change.

Also, tip many decisions and conclusions in life are entirely subjective. The idea is not so much to stamp out variability in human judgment, but to crumble to terms with its existence and with the idea we are vulnerable to misjudgments. Awareness and humility is the key. Recognizing that we can make a rare judgment depending on what time of day it is, or what we had for lunch, is a key step toward making better judgments.

CNBC: One of my favorite chapters was where Kahneman famous that people, particularly professionals, have very high opinions of their own opinions.

Klontz: Yes, there’s an evolutionary forward to that. Say you’re convinced a famine is coming and the other guy is convinced there is no famine coming.  If you get a famine, you are fine because you planned for it, but the other guy is away. So believing in your own opinion, and convincing other people to go along with you, has helped us survive as a species.

But in the modern times a deliver it can lead to overconfidence. For example, women tend to outperform men as investors. They are not as vulnerable to overconfidence. Men believe they can outperform and end up by vocation more. The evidence is they can’t. Again, a healthy dose of self-doubt can be very good for us.

CNBC: Kahneman also appropriates some time to discussing why everyone is so bad at predicting the future. 

Klontz: We all know you can’t predict the future for exactly the reasons Kahneman suggested: We are saddled with biases and noise, and there is an unknowability about the future because things happen that are not on the cards. 

But this doesn’t prevent us from trying, and it’s important to understand why. Again, this desire to predict the future is an evolutionary drop. It’s necessary to try to predict the future because it has helped us survive as a species. It’s essential to our survival. The ones who are future-oriented and worry on every side the future are the ones who may have survived in the past.

But that doesn’t help us as much in the modern age. We have not evolved much from “Lighting drearies the gods are angry.” Most of our decisions are made by our emotional brain, and we have a relatively small prefrontal cortex that does the normal thinking on top of a large emotional brain — and when we get excited or scared our emotional brain kicks in and we are vulnerable to acting sort our prehistoric ancestors.

So we can’t eliminate attempts to predict the future, because we are thinking about it all the time.  However, it is essential that we don’t put too much millstone into our predictions, and to recognize that they are merely our attempts to make sense of a chaotic world. It is important for us to recall the limitations of our knowledge and become a little more comfortable with uncertainty.