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How Thinking Costs You

Michael S. Rosenwald, of the Washington Post, has an interesting post about investing and thinking. He writes:

"Russell Fuller, chief investment officer of Fuller & Thaler Asset Management in San Mateo, Calif.

His firm uses behavioral economic theories of Nobel Prize winners and university economists to profit from the mistakes made by everyday investors and the pros on Wall Street.

Humans, no matter how hard we try, act in ways that cause us to make the wrong investment decisions almost all the time."

Ok, and what sort of ways are those?

"I asked Kahneman what fools us most frequently.

That was simple, he said: overconfidence.

"It's the idea that you know better than the market, which is a very strange idea," he said. "Individual investors have no business at all thinking they can do better."

Why do we? "It's because we have no way of thinking properly about what we don't know," Kahneman said. "What we do is we give weight to what we know and then we add a margin of uncertainty. You act on what you think will happen." That's what I did by buying Citigroup. But Kahneman added, "In fact, in most situations what you don't know is so overwhelmingly more important than what you do know that you have no business acting on what you know."

Interestingly, Mark Rubenstein, a real financial engineer, agrees with this assessment: the individual investor is over optimistic.

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Full post as published by Misleading Advertising Law on June 18, 2008 (boomark / email).