Lessons from Danny Kahneman | Investing in Practice Rather Than Theory

[00:00:00] Welcome to Two Quants and a Financial Planner, where we bridge the worlds of investing in financial planning to help investors achieve their long-term goals. Join Matt Zeigler, Jack Forehand, and me, Justin Carbonneau as we cover a wide range of investing and planning topics that impact all of us and discuss how we can apply them in the real world to achieve the best outcomes in our financial lives.

[00:00:30] Maybe holdings of clients, ability, capital or some point investments.

[00:00:33] All right guys, recently on Daniel Codeman, the well-known researcher, professor, author, psychologist, Nobel Prize winner, passed away.

[00:00:49] It was a big loss, I think, in sort of the behavioral economics or behavioral finance community given Codeman's influence on that entire spectrum of investor psychology and behavioral economics.

[00:01:06] Codeman is the author of many books, but maybe one that he's most known for is thinking fast and slow.

[00:01:13] He actually was a Nobel Prize winner, presidential medal of freedom recipient.

[00:01:20] Basically, because of his research and a few other colleagues, they launched this whole entire behavioral economics and finance feel.

[00:01:34] And a lot of what we talk about in terms of working with clients, trying to help clients, I guess, you know, get the best and helping investors get the most out of things financially in life.

[00:01:48] A lot of it can be tied back to sort of like these biases and emotions and different decision making things that investors can think through or that as advisors or investment managers.

[00:02:06] So we need to understand how people think and how decisions are made. So the, I think the thrust of this discussion is going to be working through some of the main decision making or the way that we're sort of wired as humans and how that affects decision making and then sort of talk through maybe hopefully some practical implications or things that we do when we're either in terms of that, you know, advising and helping investors with their plans.

[00:02:35] Investors with their planning or in the case of Jack and I, you know, working with clients around quantitative investment strategies.

[00:02:43] So I'll kick it over to one of you guys and let you either add to that and then we'll kind of get into some of these things.

[00:02:48] Yeah, what's interesting to me is like so much of economic and finance theory is built around this idea of what they call rational actors.

[00:02:55] And so like all these things are true or all these things will happen if you have rational actors and this is a big thing you learn from the work of condominant failure and a lot of people that worked in the spaces that the reality is people are not rational actors a lot of the time.

[00:03:10] Like so mad I don't actually have this but if I had an investment strategy that returns 50% a year, but also has 90% drawdowns a bunch of times along the way a rational actor is going to stick with that investment strategy you know through all the ups and downs and they're going to ride it through.

[00:03:24] But your average person is not a rational actor they're not going to do that and you know I was also just in my with Sephora with my daughter yesterday and you know one thing I can say about going into that place is like my daughter is certainly not a rational actor in there because I'm buying tubes of stuff that's like this big for 40 bucks and because she's not a rational actor I'm not either.

[00:03:40] So you know it's both like in our purchase decisions and our decisions and you know economics like in what we do in the markets like we're not rational actors and a lot of that finance theory you have starts to break down when you take that away and I think that to me and you can add to this map but to me that was a big takeaway of like the work of condominant.

[00:03:58] It's one of those things I have my copy I have my copy right here I have beat the crap out of this book I will say this is one of the.

[00:04:07] I hold this in regard getting through this book over probably a multi month period I think it took me months to like finish the whole thing because it's like you have to read and digest and put it down but the last thing impact of this book is brothers caramazov deep for me it's one of those things every ounce of the work was worth the effort because.

[00:04:30] This just keeps following you once you learn it like the rational actor thing like once you have it broken down torn apart put back together you just start to see it everywhere and condomin's work represents over decades and years and anybody who's touched behavioral finance or behavioral psychology in some way you've run into this work.

[00:04:50] And once you see it even the stuff that's been challenged in is failed to replicate and I was a wrong but like not useful anymore the idea of how to think about thinking there are few people who have contributed this much to thinking about thinking as Daniel condomin and we lost one of the greats in thinking fasting slow one of the I think big concepts is this idea that there's two systems of thought.

[00:05:17] And the way I like to think about it is you know you have it's not it's not the devil and the angel sitting on your shoulder but it's like kind of the crazy guy and the rational guy sitting on you know each of your shoulders sort of talking to your ears and influencing you at different times.

[00:05:35] And so you have these two systems that are actually very different than each other that are sort of.

[00:05:41] Resulting in you know a different set of decisions so so let's just let's just talk through what is what is system one and what is a system to.

[00:05:51] System one is where you you just react you know you think quickly and system two is where you give more thought to it and you make decisions and you know we're not sitting here all day like thinking oh I made this decision was system one and I made this decision was system two.

[00:06:04] But we're doing it all day and you know system one is good for certain things and system two is good for other things and you know how that works out and how you what's what it's good for and then how you actually use them as a really interesting thing because sometimes we're not doing something sometimes something that.

[00:06:22] Should require system to is actually using system one so Matt Matt you could probably add a lot to it but I think that's a lot of the stuff we're going to talk about with him all kind of comes down from this idea of system one and system two.

[00:06:33] Without using any of the big fancy words it's basically system one is your ability this is why the book is titled thinking fast and slow right there in the title system one is fast system two is slow.

[00:06:46] And the beautiful part of this idea is think about your daughter in Sephora think about any of these cases there are things we will decide on because of a gut feeling or an impulse and we will take action in that thing that's what he defines as system one thinking we take action in the moment with a medium.

[00:07:03] You see because he always take the time to get to the answer system two says wait slow down sometimes and step back and actually consider the things that are on the table for the input to this decision making process this ability to toggle between stuff where we're answering things quickly

[00:07:23] with answer things slowly is a huge deal.

[00:07:26] Because we can start to parse a part,

[00:07:30] how people actually decide to do stuff

[00:07:32] and all the problems that come with it.

[00:07:34] Stuff where I might ask your,

[00:07:37] I might ask, hey, hey, Jack's daughter,

[00:07:39] like what were you're gonna get at Sephora

[00:07:41] and what you saw in like, I don't know,

[00:07:42] a YouTube makeup tutorial or wherever

[00:07:44] she's getting her information?

[00:07:46] And there might be this complete gut

[00:07:48] already decided decision that's guiding

[00:07:50] this first part.

[00:07:51] But then rational Jack is like,

[00:07:53] look at the size of this tube.

[00:07:54] How could this possibly worth $40

[00:07:56] and ask you all these questions?

[00:07:57] For sure.

[00:07:58] I have a system one decision

[00:07:59] and a system two decision that are

[00:08:01] in inherent conflict with each other

[00:08:02] and therefore can't talk to each other.

[00:08:04] I mostly figure out a way to tear it apart.

[00:08:07] Kind of inshowing this

[00:08:08] and I have to say this too.

[00:08:10] You're gonna have to pardon me

[00:08:11] on what will likely be

[00:08:13] a semi tortured pop culture thread

[00:08:16] through this entire episode.

[00:08:18] In my sadness for losing this man

[00:08:22] is worth meant so much to my own career

[00:08:24] and my own development professionally.

[00:08:25] I'm thinking about the bone thugs

[00:08:28] at Harmony Classic at the Crossroads

[00:08:30] and love again, it's such a good song.

[00:08:33] It's just such a good song.

[00:08:35] But okay, so trivia number one,

[00:08:37] do you know it's about a lot of people

[00:08:40] but do you know who largely that song was directed by

[00:08:42] and I have a great system one

[00:08:43] and two less than to derive from this?

[00:08:45] No, I do not.

[00:08:47] Like a lot of people don't know

[00:08:48] that that song is basically in homage to EZE from NWA

[00:08:55] and that's because they got signed to EZE's label

[00:08:58] in the wake of the post-NWA stuff.

[00:09:01] But here's the crazy thing,

[00:09:02] here's system one and two thinking

[00:09:04] in a way that a teenager can understand.

[00:09:06] Bone thugs, many people also don't seem to realize

[00:09:10] is from the urban center of Cleveland, Ohio.

[00:09:15] Cleveland is not exactly

[00:09:17] the epicenter of hip hop in like the early 90s.

[00:09:21] So they decide, they wanna get a record deal

[00:09:24] and they want to get on,

[00:09:25] they didn't they know EZE is signing artists.

[00:09:28] So they decide to buy one way tickets

[00:09:30] from Cleveland to LA.

[00:09:34] So they get on a bus for a three day trip.

[00:09:37] This is a system one decision.

[00:09:39] When you're like, I know what I want,

[00:09:40] I want a record deal.

[00:09:42] They got on a bus for three days

[00:09:44] ended up staying in LA for four months

[00:09:46] because they couldn't get a meeting with EZE.

[00:09:49] The thing that gets them back to Cleveland

[00:09:52] is they finally find out from somebody else

[00:09:54] that EZE is doing a show in Cleveland, system two.

[00:09:58] Oh, he's gonna be in Cleveland, our hometown.

[00:10:01] They figure out they know who the promoters gonna be

[00:10:03] who's doing the show and all this other stuff.

[00:10:05] They slow down the take the logic,

[00:10:06] they buy one way tickets,

[00:10:08] they go all the way back to Cleveland

[00:10:10] and that's when they finally get a shot

[00:10:11] to do the audition, they get signed,

[00:10:13] the rest is kind of history.

[00:10:15] But this balancing act between decisions

[00:10:17] we make with our gut that sometimes don't work out.

[00:10:19] Sometimes we get lucky and the ones that we slow down

[00:10:22] make cautiously and how they can work out,

[00:10:24] they might not too.

[00:10:25] But we have to think of them in different ways

[00:10:27] at different speeds.

[00:10:29] Damn system one and two.

[00:10:31] It's so useful in and of itself.

[00:10:33] Matt, my daughter is gonna thank you

[00:10:35] next time we go to support when I give her a copy

[00:10:36] of thinking fast and slow

[00:10:37] or tell her she has to read it

[00:10:38] before she makes any decisions.

[00:10:40] Big fast and slow is the makeup of the mind.

[00:10:43] I am sure we can sell that.

[00:10:45] Bit of a dense book though,

[00:10:46] so she may not she's nine.

[00:10:48] So she may not make it through.

[00:10:50] But I'm effectively nine years old

[00:10:52] and I made it through it.

[00:10:53] So she has a chance.

[00:10:55] What I need to tell her is no more makeup

[00:10:56] until she makes it through it.

[00:10:58] Okay.

[00:10:58] Or whatever she's getting there.

[00:10:59] It's not makeup.

[00:11:00] I don't even know what it is.

[00:11:01] She gets that you give her the book.

[00:11:02] I'll give her a bone thug CD.

[00:11:03] We'll see which one wins out.

[00:11:05] We'll see how it works out.

[00:11:06] It was interesting just in doing

[00:11:08] some little bit of prep for this.

[00:11:09] It was, I think it was a post on LinkedIn.

[00:11:11] The guy was saying that, you know,

[00:11:14] the system won.

[00:11:16] We make more decisions with system one

[00:11:19] than we'd like to admit.

[00:11:21] And then he sort of was,

[00:11:23] he kind of like parlayed it into

[00:11:26] when you're marketing to consumers.

[00:11:30] You know, a lot of times companies

[00:11:32] will market like the numbers

[00:11:33] in the rationale and like the product features.

[00:11:35] When in reality, it's like,

[00:11:38] you want to mark it on sort of like

[00:11:40] the things that are going to get a reaction

[00:11:43] out of system one.

[00:11:45] And you know, because more decisions

[00:11:47] are being made that way.

[00:11:48] And I just kind of got me thinking

[00:11:50] just trying to relate it back

[00:11:51] to like investing a little bit is,

[00:11:53] you know, I think what Robin Hood did

[00:11:56] and listen, it got a lot of young investors

[00:11:58] started really quickly.

[00:12:00] But obviously during, into the markets

[00:12:02] and investing, but you know,

[00:12:03] I think they were hitting with some

[00:12:05] of the confetti coming down

[00:12:06] and the way the app was built

[00:12:08] and stuff, it's like they were feeding off

[00:12:11] of you know, the system one type

[00:12:13] of decision making in terms of,

[00:12:15] you know, being able to buy those stocks

[00:12:17] very easily and all the rewards that are there.

[00:12:19] And you know, sort of stuff like that.

[00:12:21] But then again, you know,

[00:12:22] system two can also hurt investors

[00:12:25] in the sense that you can get,

[00:12:27] you can do too much analysis.

[00:12:28] You can kind of have the information fatigue.

[00:12:32] And so these things can work

[00:12:35] for or against you depending on

[00:12:37] sort of how you're looking at them.

[00:12:39] Those balancing acts of the two

[00:12:41] and understanding the two, understand when,

[00:12:44] like if I'm giving somebody too much information

[00:12:46] analysis paralysis is happening,

[00:12:48] I need to figure out a way

[00:12:49] to talk the system one to help them through it

[00:12:51] we'll get into framing

[00:12:52] and some other stuff I am sure.

[00:12:54] And vice versa, if people are just plugging

[00:12:56] into the dopamine machine and trading stuff

[00:12:59] based on like the stock move

[00:13:01] to Nathan a point or whatever it is

[00:13:03] like in the afternoon

[00:13:04] and I need to go trade again,

[00:13:06] I need to get them to step back

[00:13:07] and see some system two thinking

[00:13:08] and how they're approaching this whole process.

[00:13:11] I'll never forget talking to a guy

[00:13:13] in the like the post global financial crisis thing

[00:13:16] and it's a younger guy,

[00:13:19] he's working in like the finance department

[00:13:20] of a car dealership

[00:13:21] and he's basically flexing his knowledge upon me

[00:13:24] with how good of a trader he is

[00:13:25] and it's like I don't want you as a client

[00:13:27] or need you as a client

[00:13:28] but if you wanna tell me

[00:13:29] how great your trading strategy is, sure.

[00:13:32] And he's telling me these stories

[00:13:34] and about all these trades that he's doing

[00:13:37] and I was like so like,

[00:13:38] how do you think about the taxes for that?

[00:13:40] That's amazing

[00:13:41] but there's a lot of like short-term capital gains.

[00:13:43] He had no idea what short-term capital gains were

[00:13:46] and I remember being like I have completely deflated

[00:13:49] this kid's hope for like his future

[00:13:52] when I told him how much he's gonna have to give Uncle Sam

[00:13:55] still feel bad about that a little

[00:13:57] but tear point it's

[00:14:00] you gotta think at these both levels

[00:14:01] and understand they're being used against us

[00:14:03] all the time too.

[00:14:04] Do you think Matt like recognizing Justin's point

[00:14:07] that a lot of times you can overthink these things

[00:14:09] but do you think system one in general is

[00:14:12] worse for long-term investors?

[00:14:13] Like I was trying to think about like

[00:14:14] the types of decisions long-term investors make

[00:14:17] where system one would be good.

[00:14:18] It seems like it works against them more

[00:14:20] than it works in their favor

[00:14:21] but what do you think about that?

[00:14:24] So again, I don't think you can separate the two

[00:14:26] because no matter what

[00:14:27] they're still they last bit

[00:14:30] there's a first mile and like a last mile thing

[00:14:33] that happens within tuition and inside of system one

[00:14:35] when stuff needs to occur.

[00:14:37] And there's also a filtering mechanism

[00:14:38] that's always happening inside of system one

[00:14:40] and we need to know when there's an environment

[00:14:42] when we need to slow down and think about it

[00:14:46] and there's also environments where we need

[00:14:47] to speed back up and get something done.

[00:14:50] So there's the paralysis of being like

[00:14:52] I don't know really how to think about

[00:14:54] this abstract concept of retirement

[00:14:56] but there's also the reality of like

[00:14:58] okay, I gotta make sure that thing is going

[00:14:59] into the 401K and if I'm gonna walk away.

[00:15:02] So from an investing and planning standpoint

[00:15:04] these are two of those things that

[00:15:07] thanks for reading books like this.

[00:15:08] This is forever in my head

[00:15:09] when I'm communicating with people

[00:15:11] and seeing is this being led by intuition?

[00:15:14] Is this being led by some slow thoughtful thinking

[00:15:17] and how can I shift people back and forth

[00:15:19] between the two to make progress?

[00:15:22] I wonder if system one,

[00:15:26] if your if if system one, I'm gonna say people

[00:15:31] but we all have these systems.

[00:15:32] So it's like, but maybe

[00:15:36] you're more likely to take risks

[00:15:40] if system one is a little bit more dominant

[00:15:42] and you're a little bit more conservative

[00:15:43] if system two is a little bit more dominant

[00:15:46] in the decision making process.

[00:15:49] I don't know if you could categorize it exactly.

[00:15:50] I was just thinking like,

[00:15:54] and maybe there's luck involved too.

[00:15:55] I'm thinking of like somebody that bought

[00:15:56] in the video like maybe five years ago

[00:15:59] and a system two driven thinker might be like,

[00:16:02] you know what?

[00:16:03] I don't really understand the business so much

[00:16:05] or I didn't see so sort of,

[00:16:07] I don't know.

[00:16:08] So maybe you would get into some opportunities

[00:16:11] than some of those opportunities would be just blowups.

[00:16:15] I don't know, that's a good thought.

[00:16:16] I think it was both ways because fear can drive

[00:16:18] so much of system one I would think.

[00:16:20] And so fear can drive it in the other way,

[00:16:22] the opposite of risk taking

[00:16:23] like you're just processing stuff in the minute

[00:16:25] and you're like,

[00:16:26] that's just gotta get out of this.

[00:16:27] You gotta sell this,

[00:16:28] you gotta do this because I can't.

[00:16:29] So I don't know what you think that.

[00:16:31] It probably works both ways, I guess.

[00:16:33] The premise of this

[00:16:35] and the premise of prospect theory

[00:16:37] that I'm sure we'll touch on too

[00:16:38] is we are talking about decision making

[00:16:41] under uncertain conditions.

[00:16:46] And so like with all those things,

[00:16:47] whichever way you're citing or leaning

[00:16:49] or resulting in the final action or inaction

[00:16:52] it's decision making

[00:16:55] under uncertain conditions, under uncertainty.

[00:16:58] And that's the reality that we're all operating in.

[00:17:00] And yes, some people can be more dominant in one

[00:17:03] than the other.

[00:17:03] We know people who are just pure impulse all the time

[00:17:05] and other people who are pure paralysis all the time.

[00:17:08] But for the most part,

[00:17:09] all of us are switching back and forth constantly.

[00:17:11] That's a feature not a bug of how our brains work

[00:17:14] but the better we at least can understand it.

[00:17:17] One of my favorite parts about the book too towards the end

[00:17:19] he's like,

[00:17:20] oh hey by the way,

[00:17:21] I'm not immune from any of this stuff.

[00:17:23] It doesn't even make me a better decision maker.

[00:17:25] It just means maybe we can improve

[00:17:28] water cooler conversation about these things

[00:17:30] which just in teardrop point.

[00:17:32] I think is a profound point here.

[00:17:34] Just talking about this stuff and of being aware of it

[00:17:36] is half the battle.

[00:17:38] So let's go to prospect very then.

[00:17:42] How would you,

[00:17:43] this one's a little bit,

[00:17:44] and this is, I think for Connemon

[00:17:45] this is like kind of groundbreaking.

[00:17:47] This was one of the,

[00:17:48] I mean all these are,

[00:17:50] but this was I think in the sort of academic world

[00:17:52] like what was one of the main theories

[00:17:58] that he was most widely known for.

[00:18:00] And Matt, I guess it's around this idea

[00:18:05] of when you have these uncertain conditions

[00:18:11] let's take a stock for example,

[00:18:13] or an investment you have.

[00:18:16] You're placing different values.

[00:18:19] There's asymmetric values.

[00:18:22] You're placing on whether or not you have

[00:18:25] like a gain or loss on something.

[00:18:27] So we often hear sort of the idea

[00:18:30] that investors feel lost as twice as much

[00:18:32] as they feel gains.

[00:18:35] And it's probably somewhere around there,

[00:18:37] and it varies for each investor.

[00:18:39] But let's just shake out this idea

[00:18:42] of what prospect theory actually is

[00:18:44] and some examples of it in real life.

[00:18:48] So this stuff gets tricky.

[00:18:52] There's a lot of words and definitions involved.

[00:18:54] I encourage people to like zoom out

[00:18:56] and I'm gonna try to explain as much of this

[00:18:58] with as few as the technical terms as possible.

[00:19:01] But the key idea inside a prospect theory is that

[00:19:06] well we,

[00:19:07] the act of making a decision

[00:19:09] is in and of itself a biased act.

[00:19:12] There's nothing without bias.

[00:19:14] Bias is always there.

[00:19:16] It's always with us.

[00:19:17] We don't make bias free choices.

[00:19:19] We have a bias in the choices that we decide between.

[00:19:24] Like the choices that we put on the table

[00:19:26] have bias in them too from ourselves and from others.

[00:19:30] So we have to like accept this first.

[00:19:34] Now behind that is this idea

[00:19:36] that came out of condominant interversities work,

[00:19:39] which is basically that we don't make choices between things.

[00:19:43] We make choices therefore between descriptions of things.

[00:19:48] Full stop, this is one of the most important senses

[00:19:49] I think I've ever understood in my life.

[00:19:52] We don't make choices about a thing.

[00:19:54] We make choice about a description of a thing

[00:19:57] and that's really profound

[00:19:59] because that means the way the table is set,

[00:20:01] the way the information is presented to us,

[00:20:03] the choices we put on the table are actually the things

[00:20:07] are understanding of them

[00:20:10] or how we are going to decide.

[00:20:12] And that is profound implications.

[00:20:14] Right into the point you were making Justin about this idea

[00:20:18] that you can people are risk averse when the stakes are high.

[00:20:21] So like if the market is crashing

[00:20:23] and I'm wondering from the lose my retirement,

[00:20:25] I'm gonna be risk averse which is as you know,

[00:20:27] value investor types especially like ward buffet.

[00:20:31] There's blood in the streets.

[00:20:32] This is not the whole store is huntsail.

[00:20:34] This is not the time to be risk averse

[00:20:37] but that's what the data says.

[00:20:38] And it also says people tend to be risk accepting

[00:20:41] when the stakes are low.

[00:20:42] So when it's something that doesn't really matter

[00:20:44] I might buy a scratch off lottery ticket

[00:20:46] when it doesn't really matter

[00:20:47] when volatility is really low

[00:20:49] I might feel confident about like,

[00:20:51] oh of course the stocks are gonna continue to go up

[00:20:53] or whatever it is.

[00:20:55] And prospect theory is basically a way to center us

[00:20:58] on this idea that all of our choices are biased,

[00:21:01] all of our options are biased

[00:21:02] and we're gonna be making our decisions in our heads

[00:21:05] based on the descriptions of the things as they are occurring.

[00:21:10] Jack what would you add to that?

[00:21:13] Well this kind of gets back to what I was saying before

[00:21:14] like this whole rational actor thing I was talking about

[00:21:16] like rational actors wouldn't do any of this stuff

[00:21:18] you're talking about.

[00:21:19] You know, rational actors wouldn't even play the lot

[00:21:21] in the first place they wouldn't value descriptions

[00:21:24] of the things over the things

[00:21:25] and that's why this theory is so important

[00:21:27] because it gets into what actually happens

[00:21:29] in the real world.

[00:21:30] And so much of this theory of

[00:21:33] if you go get two finance professors to develop a theory

[00:21:36] when you should play the lottery

[00:21:38] the theory is gonna be you should never play the lottery

[00:21:41] because there's no point in playing the lottery

[00:21:43] but all of us that I'm still on buying scratch

[00:21:45] also my wife's still regularly as much as I don't wanna do that.

[00:21:48] But like again,

[00:21:50] rational jack being overtaken by this

[00:21:52] you know if not the way things work in the real world

[00:21:55] so I think as we work through this

[00:21:56] this is gonna be one of the big takeaways

[00:21:58] of all of this is like this is all about recognizing

[00:22:01] you know the difference between the rational actor

[00:22:03] and the real world actor.

[00:22:05] And that rational piece like what you just brought up too

[00:22:08] is even when we talk about rational

[00:22:10] that's you're assuming complete information about something.

[00:22:13] There's very rarely anything you have complete information on

[00:22:16] or it's not a math formula.

[00:22:18] So therefore even the thing

[00:22:19] even the as we've seen with some of the AI attempts

[00:22:22] with these bots

[00:22:23] even the AI bots have bias embedded in them

[00:22:26] from the information that's presented to them.

[00:22:29] This is a crack

[00:22:30] and that foundation of how we understand the human experience

[00:22:33] and that's part of why it's so damn important.

[00:22:36] You know and I think to use this to jump off

[00:22:41] to the next bias is sort of this idea of anchoring.

[00:22:50] And what the reason I think it's important

[00:22:53] to kind of link these two things specifically

[00:22:55] if you think about bear markets

[00:22:57] you know a lot of times what investors tend to do

[00:22:59] and Jack we've talked about this

[00:23:00] and Matt we've talked a lot

[00:23:02] and investors tend to want to think they're going to fight

[00:23:06] the last battle.

[00:23:07] So you know like if you think of the 2008 financial crisis

[00:23:14] thinking that like the next bear market

[00:23:18] it's going to be similar to that

[00:23:19] like investors anchor on their past experiences

[00:23:23] and those types of things can you know

[00:23:26] drive a lot of their behavior

[00:23:29] and decision making.

[00:23:31] And so that's something that we all sort of have in us

[00:23:34] and we only can all we know is our past experiences

[00:23:39] of what we've been through

[00:23:41] thinking that those are going to be

[00:23:43] how it plays out in the future

[00:23:44] so we anchor on those past experiences

[00:23:46] but oftentimes I mean there's so many different outcomes

[00:23:50] and you know oftentimes doesn't look very similar

[00:23:55] to what it was in the past.

[00:23:58] The biggest example of this to me

[00:23:59] is the price I pay for the stock.

[00:24:02] Once I pay a price for a stock it's over

[00:24:05] like that price has nothing to do with my decision

[00:24:07] I mean other than taxes obviously

[00:24:09] because if you have a gain or a loss or whatever

[00:24:10] but like if you take taxes out of it

[00:24:12] if I'm operating in a retirement account

[00:24:13] like what that price I paid should have nothing to do

[00:24:16] with my future decisions regarding that stock

[00:24:18] like what that stock is worth whether it's under value

[00:24:20] whether it's over valued

[00:24:21] if I paid $20 and has nothing to do with that

[00:24:23] but yet I'm going to anchor on $20

[00:24:25] wherever basically because I paid $20

[00:24:28] you know and that's the big thing is like those things

[00:24:31] that information you kind of have at the beginning

[00:24:33] that may not matter anymore it continues to matter

[00:24:37] even though it's not the greatest way to explain it that

[00:24:39] but that's the best example I was like a vankering.

[00:24:42] No, it's a perfect example

[00:24:43] and this goes back to you put the puzzle piece

[00:24:46] on the table in this case

[00:24:49] like you bought the stock you have the price that you bought

[00:24:52] the market has already forgotten the price you bought it for

[00:24:54] like after that transaction it moved away

[00:24:57] no one else in the world actually cares

[00:24:59] except you your accountant in the IRS

[00:25:02] and that is an arbitrary piece that now you have put on the table

[00:25:06] that's going to influence your decision making

[00:25:08] from that point going forward.

[00:25:10] Profound thought again just to acknowledge it exists

[00:25:13] asking people are trying to untangle without asking them

[00:25:16] directly what people are anchored on in decisions

[00:25:19] we see this all the time in a planning perspective

[00:25:22] people have a date

[00:25:24] just the other day talking to somebody

[00:25:26] and they had retirement at 65 like stuck in their head

[00:25:30] and they for whatever reason thought like Medicare

[00:25:33] Social Security a bunch of other stuff started at this date

[00:25:35] because that's their retirement date and that's the age

[00:25:37] and there are enough years away from it

[00:25:39] where it was just

[00:25:41] who's an abstract concept that at some point in time

[00:25:44] this idea got stuck inside their head

[00:25:46] it was anchored there

[00:25:47] when we had to talk around a bunch of stuff till I realized

[00:25:50] oh, like you think all this stuff has tied to this one date

[00:25:54] and it's not

[00:25:55] but we have to unpack what that is

[00:25:57] because that's how our brains work.

[00:26:00] Another bone thugs example

[00:26:01] first of the month

[00:26:03] that's the day the welfare checks come

[00:26:05] everything else revolves around this date

[00:26:07] and you can imagine as it marches through time

[00:26:09] like on the first of the month

[00:26:11] everybody's hanging out

[00:26:12] having a good time good things are happening

[00:26:14] very good for the local drug dealing community

[00:26:15] as we learn in the third verse of the song

[00:26:17] but I'm sure on like the 20th of the month

[00:26:19] when everybody's strapped and everybody's worried

[00:26:22] it's very different than on like the 30th of the month

[00:26:24] or the 28th in February

[00:26:26] when everybody's in anticipation of the next day

[00:26:29] the pieces that are on the table

[00:26:30] the things we anchor to

[00:26:32] logical or not

[00:26:33] rational or irrational

[00:26:35] have a direct influence on the choices we make

[00:26:38] I think the price you pay for a stock

[00:26:40] is a perfect, perfect example to use here, Jack.

[00:26:44] Yeah, and you know, this is going back to your other point

[00:26:46] like even the people who understand this still doing

[00:26:48] like I still anchor on the price I paid for a stock

[00:26:51] I'm like I paid 20 bucks for that

[00:26:52] I can't help that.

[00:26:53] I'm not selling that thing for 12

[00:26:54] like what it doesn't the market know that I paid 20

[00:26:56] like there's no way I'm doing that

[00:26:58] like all the guys and we know what I,

[00:26:59] like the work of Daniel Krosbe is really good

[00:27:01] around this area too

[00:27:02] like all these guys that know

[00:27:05] all that have studied this forever still do it

[00:27:08] and that's the biggest thing

[00:27:09] like for every investor to understand about this

[00:27:12] I think because when you start to learn this stuff

[00:27:14] you start to think oh I'm gonna combat this

[00:27:16] like I'm not doing this

[00:27:18] like I'm gonna overcome this anchoring

[00:27:19] and all these other body but you can't really do it

[00:27:22] and so it's like the recognition that you understand this

[00:27:24] but you can't overcome it is kind of the place

[00:27:26] you have to get to use this in the proper manner

[00:27:30] And by the way I think my bear market example

[00:27:32] might be a little bit better

[00:27:34] I kind of may misdefined anchoring there

[00:27:38] because I think the availability heuristic

[00:27:40] is more the idea that we tend to wait

[00:27:44] more recent events in our minds more heavily

[00:27:47] and the decisions are based on

[00:27:51] you know, decisions can be based on that

[00:27:53] and so like example of

[00:27:58] you go through a bear market

[00:27:59] and then you buy the permanent portfolio

[00:28:04] and then assets go from like 100 million to 13 billion

[00:28:08] and then the permanent portfolio is like

[00:28:11] ends up getting left in the dust by all other strategies

[00:28:14] so that's a type of thing that I think

[00:28:17] that availability heuristic sort of captures

[00:28:21] yeah, that was a good one

[00:28:22] like our interview we did in excess terms

[00:28:23] with Mark Higgins is a good example of that

[00:28:24] because when we're looking at any historical event

[00:28:27] anything that's happening right now

[00:28:28] whether the inflation you know

[00:28:29] we had bank failures recently

[00:28:31] we always want to like go back

[00:28:32] to what's the most recent thing

[00:28:34] or what's the thing we've seen the most

[00:28:35] that kind of explains that

[00:28:37] and you know a lot of times that's not the best thing

[00:28:39] and so he looked at

[00:28:40] you know when he looked at inflation

[00:28:41] or when he looked at the pandemic

[00:28:42] he was tying it to periods in history

[00:28:45] that I would never have thought to tie it to

[00:28:46] because I'm just like oh bank failures 2008

[00:28:48] that's what's happening

[00:28:49] like we're going to have a financial crisis

[00:28:51] and it's so important like to do that

[00:28:53] to realize that you're doing it

[00:28:55] and realize that you know

[00:28:56] just because something happened more recently

[00:28:58] doesn't mean it's more relevant

[00:28:59] to what you're dealing with it

[00:29:00] and again you can't overcome this

[00:29:01] and I still do it

[00:29:02] I still reference 2008 all the time

[00:29:04] when I see things you know

[00:29:05] doom and gloom stuff

[00:29:06] but it's just important to understand you're doing

[00:29:08] because it might make you think

[00:29:09] a little more broadly about the potential things

[00:29:12] you know you can use as examples

[00:29:13] of what you're dealing with.

[00:29:14] The easier it is to recall something

[00:29:16] the more available it is to you

[00:29:18] especially in the where you feel it

[00:29:20] and that's why bear markets are such a good example

[00:29:22] Justin, you feel that thing

[00:29:25] you live through it

[00:29:26] so you feel that things somewhere in your core.

[00:29:29] That availability of that knowledge

[00:29:31] in your head is what puts the piece on the table

[00:29:34] that piece on the table

[00:29:35] which is the anchoring concept really at play

[00:29:38] is now that feeling becomes an emotional anchor

[00:29:41] for how you'll act

[00:29:42] and we see this in the very short run

[00:29:44] where we see things with availability

[00:29:47] another great example is when you

[00:29:49] if you've never seen a

[00:29:50] remember being a kid

[00:29:51] like you've never seen a word before

[00:29:53] and then you see a word

[00:29:54] and then you see it everywhere

[00:29:56] and you're like I know this word existed

[00:29:57] out of space in time

[00:29:58] but like I was not thinking of it

[00:30:00] the car dealer thing from before

[00:30:02] I remember I was getting a Kia of all things

[00:30:05] I was getting a Kia in like 2015

[00:30:07] because of the safety rating on this SUV

[00:30:10] and whatever else

[00:30:11] and all I could think of

[00:30:13] like I didn't want to get a Kia

[00:30:15] because I still had something

[00:30:17] from the year 2000 when they did their

[00:30:18] why-to- Kia campaign

[00:30:20] and I remember a friend's dad

[00:30:21] who was the car dealer

[00:30:22] like making fun of the company

[00:30:24] and I was just like

[00:30:24] Kia is there bad forever

[00:30:25] and then here I am in a consumer reports

[00:30:27] going like this is the safest SUV

[00:30:29] I can buy this year.

[00:30:31] It's all anchoring

[00:30:32] it's all availability oristic

[00:30:34] it's all the pieces are brain

[00:30:35] want to default put on the table in front of us

[00:30:38] and how often do we just stop slow down

[00:30:40] and go what would that was this piece even doing here

[00:30:42] and you made a really important point

[00:30:44] is it's like when memorable

[00:30:45] and recent come together

[00:30:46] that's where this is an issue

[00:30:48] because like the market did something last Tuesday

[00:30:50] but I don't remember what the market did last Tuesday

[00:30:52] that was recent but it wasn't memorable

[00:30:54] like 2008 was both recent

[00:30:55] I mean it's not recent now

[00:30:56] but recent in terms of a major bear market

[00:30:58] and memorable

[00:30:59] and when those two things come together

[00:31:01] that's where this really kicks in

[00:31:02] where we're like this is you know

[00:31:03] this is what's gonna happen again

[00:31:05] and this is this is the premise of

[00:31:07] you know this is why we read stuff

[00:31:09] like the fourth turning and things like that too

[00:31:11] because this is the premise of shared experiences

[00:31:14] with people that become memorable

[00:31:16] very importantly these are usually not rational things

[00:31:19] that are memorable

[00:31:20] these are our felt responses to things

[00:31:22] that are actually becoming memorable

[00:31:24] and that's what's so important

[00:31:25] because it's really powerful

[00:31:26] because who knows what happens last Tuesday

[00:31:28] but we remember that you know

[00:31:30] month long slide at the beginning

[00:31:31] of the COVID pandemic

[00:31:32] and what happened to our accounts.

[00:31:35] I wonder if this contributes to

[00:31:38] some of the thought process

[00:31:43] of traditional systematic

[00:31:46] obviously what you think about this Jack

[00:31:47] like value investors

[00:31:49] sort of you know a few years after the financial crisis

[00:31:54] sort of see I want to use the word anchor ring

[00:31:57] which is not but you know

[00:31:58] thinking back to the run that value had

[00:32:02] in 2000 from 2005 and thinking that

[00:32:06] value is going to turn

[00:32:08] and then it took basically like kind of 13 years

[00:32:12] until like 2020 or value to turn

[00:32:15] like you know buying these cheap stocks

[00:32:17] waiting for waiting for that reversion

[00:32:20] and it really never didn't happen until

[00:32:23] you know it's only been a short period of time

[00:32:25] anyway since the you know

[00:32:27] I don't know what you think

[00:32:28] do you see I'm going with that

[00:32:29] that's a really really good example

[00:32:31] because like all of us that are value investors

[00:32:33] who've been waiting for this turn forever

[00:32:35] are going to look at 2000 to 2002

[00:32:37] and be like this is what's coming.

[00:32:39] I saw it, I saw my own eyes

[00:32:40] I got you know the market was the best thing

[00:32:42] you could ever have happened to you

[00:32:43] the markets going down a lot

[00:32:45] and you're going up a lot as a small cap value investor

[00:32:47] like it doesn't get any better than that

[00:32:48] so like if there's anything

[00:32:50] you're going to anchor to

[00:32:51] it's going to be that if you're a value investor

[00:32:53] because you want to see that happen again

[00:32:55] the problem is that I'm not saying

[00:32:56] you know I'm a big believer in value

[00:32:57] so I'm not saying value is not going to come back

[00:32:59] but it's probably going to look different

[00:33:00] the 2000 to 2002

[00:33:02] although all of us are back on that exact thing

[00:33:04] it's probably going to play out differently

[00:33:06] and it has played out differently so far

[00:33:08] so that's a great example of this

[00:33:10] you know no matter what it is

[00:33:11] you think is going to happen

[00:33:12] or you want to happen in the market

[00:33:14] you tend to find these examples

[00:33:15] that were very powerful and very recent

[00:33:18] and then you go to them

[00:33:18] and you're like this is going to happen again

[00:33:20] and then it does.

[00:33:22] I'm sure we're going to get there

[00:33:23] but I'm just going to draw it on the table right now

[00:33:25] this is a part or a form of

[00:33:27] what condominium called overconfidence

[00:33:30] and I think it's really important

[00:33:31] to think of overconfidence here

[00:33:33] as we overestimate our abilities

[00:33:37] to understand the present

[00:33:39] to predict the future

[00:33:40] to make sense in the past

[00:33:42] like this is just

[00:33:43] there's a whole body work around this

[00:33:44] but it's this idea of being overconfident

[00:33:46] and an outcome

[00:33:47] and we see it investing strategies all the time

[00:33:50] this is why the

[00:33:52] the explanation for like the momentum factor is

[00:33:56] the under reaction to good news as it's happening

[00:33:59] so we're overconfident in thinking like

[00:34:02] surely this can't just keep getting better

[00:34:04] this stock can't just keep coming up

[00:34:06] or going up

[00:34:07] and it's that under reaction to the good news

[00:34:11] that lets this thing go higher

[00:34:12] and higher and higher

[00:34:13] that's one of the reasons why momentum

[00:34:15] as a factor likely works

[00:34:17] value on the other side

[00:34:18] it's the overreaction to bad news

[00:34:20] and this is one of the hardest things

[00:34:21] as value investors

[00:34:22] because it can almost always get worse

[00:34:24] if that negative momentum thing

[00:34:26] until it stops really, really sucks

[00:34:29] it is really no fun to go through

[00:34:31] especially when you're anchoring on a prior crisis

[00:34:33] and how something played out

[00:34:35] so that overconfidence

[00:34:38] that bias in her heads

[00:34:39] to think like we have the right lens

[00:34:41] to see the world through to get this next detail right

[00:34:44] that can sneak up in the butt and bite you

[00:34:46] that's a bunch of friends in Cleveland

[00:34:50] buying one way tickets to LA

[00:34:52] thinking they're gonna be famous rappers

[00:34:54] when they get off the bus three days later

[00:34:56] and then getting the surprise

[00:34:58] overconfidence is a beast

[00:35:00] lurking in our heads

[00:35:01] just waiting to get us into trouble

[00:35:03] yeah Matt before we talk about overconfidence

[00:35:05] I did want to provide my 2024 macro outlook

[00:35:08] because I think I've got an idea

[00:35:09] please please please

[00:35:10] I figured out what the Fed's gonna do

[00:35:11] I've got it all down now

[00:35:12] so as much as we overconfidence

[00:35:15] could be a problem for people

[00:35:16] like I think people want to hear what I have to say

[00:35:19] clearly I hope he can like insert some weird

[00:35:21] like there was an error

[00:35:23] in the recording graphic read now

[00:35:24] speak for something

[00:35:26] but it is funny

[00:35:27] like all the things we think we can predict

[00:35:29] that we can't predict like

[00:35:30] first of all anything with macro

[00:35:31] with inflation with the economy

[00:35:33] like I think I can figure some of that stuff out

[00:35:35] like there's no chance I can actually figure that out

[00:35:37] like I can't figure it out

[00:35:38] a lot of the really really well-treated macro forecasters

[00:35:41] can't figure it out

[00:35:42] a lot of the newsletters you'll see around that

[00:35:44] can't figure it out

[00:35:45] like in that area it's a huge thing

[00:35:46] we think we can figure this stuff out and we can't

[00:35:48] like stock picking is another great example

[00:35:50] like we think we can pick stocks

[00:35:52] and we can beat the market

[00:35:53] the data overwhelmingly tells us

[00:35:55] we cannot pick individual stocks

[00:35:56] and beat the market

[00:35:57] or at least the vast majority of us can

[00:36:00] it's just interesting

[00:36:01] like you see this everywhere

[00:36:02] when you think about it

[00:36:03] like you see it in terms of

[00:36:04] you know if you've seen that thing

[00:36:06] about like when people ask you

[00:36:06] if you're an above average driver

[00:36:09] pretty much everybody raises their hand

[00:36:11] pretty much everybody thinks they're above average driver

[00:36:14] and if you ask them

[00:36:15] the one you really get people with is

[00:36:16] if you ask them if you're an above average father

[00:36:18] like 99% of the people are mother

[00:36:21] you know 99% of the people will tell you that they are

[00:36:23] but 99% of the people cannot

[00:36:25] be so it's in every aspect of our lives

[00:36:28] you know we just think

[00:36:29] we're better than we are at a lot of things

[00:36:31] and again like you can't overcome this

[00:36:34] you're gonna it's something you're gonna do

[00:36:36] but at least recognizing it

[00:36:37] and be able in certain situations

[00:36:39] when I'm about to put in that stock pick

[00:36:41] you know for that penny stock

[00:36:42] where I'm like this thing is going up

[00:36:43] I've got it like being able to take a step back

[00:36:45] to system two maybe for a second

[00:36:47] to think about it before I make the decision

[00:36:49] like I can at least be a little bit better

[00:36:51] even if I still think I'm gonna get the next one after that.

[00:36:54] I always go back to the

[00:36:57] they actually call it the lake will be gone

[00:36:59] a fact you can go look that piece out

[00:37:01] but from Garrison Keeler in a prairie home companion

[00:37:03] and the sound of my childhood

[00:37:05] on long drives living the NPR

[00:37:08] and that idea of where all the women are strong

[00:37:11] oh this is the key part here

[00:37:13] to your raise your hand if you're a good driver

[00:37:15] and 70% of the room is gonna

[00:37:16] or 80% puts their hand up

[00:37:18] where all the women are strong

[00:37:20] all the men are good looking

[00:37:21] and all the children are above average

[00:37:23] it is a fictional land

[00:37:25] we're all over confident

[00:37:27] outputs over outcome that all we can do

[00:37:29] is control the things that we're gonna do

[00:37:30] and even that doesn't promise the outcome

[00:37:33] that we're after so this is where habits come into play

[00:37:37] this is where just figuring out basic stuff

[00:37:39] becomes our best defense in terms of long term

[00:37:42] successful outcomes.

[00:37:43] Yeah I'm just just two things to add to this point

[00:37:47] is it's important to think of

[00:37:51] forecast and predictions

[00:37:53] in the terms of base rates

[00:37:56] so that's something that Michael Madison has talked a lot about

[00:37:59] so when you hear someone giving

[00:38:01] that seems super confident and authoritative

[00:38:03] you know what you want to also hear

[00:38:05] is some probabilities assigned to those predictions

[00:38:10] and then the other point is

[00:38:13] this is where when you can

[00:38:16] automate or systematize your

[00:38:20] decision making process or investments

[00:38:22] I'm thinking of investing strategy specifically

[00:38:24] like when you build quantitative models

[00:38:28] you know they're far from perfect

[00:38:31] but they do help overcome some of these biases

[00:38:35] that can work their way in

[00:38:37] to the decision making process

[00:38:39] and so that's something that we do

[00:38:41] I know Madison believer in quant strategies

[00:38:44] and so thinking about that in terms of

[00:38:47] how you can overcome some of these

[00:38:49] with certain types of investment processes

[00:38:51] and strategies is also important.

[00:38:55] Yeah now that's a hard initial decision to make

[00:38:57] because we all are overconfident

[00:38:58] of what we can do so that

[00:39:00] that decision to hand things over

[00:39:01] to like a systematic process

[00:39:02] or even the hand things over to an index fund

[00:39:04] it can be a hard decision

[00:39:05] because you think in your own mind

[00:39:08] like I can do better than this

[00:39:09] I can perform better

[00:39:10] whatever it is

[00:39:11] and like even if the data tells you

[00:39:13] going back to what you're saying

[00:39:15] about looking back at base rates

[00:39:16] if the data tells you that 90% of people

[00:39:18] who try to beat the market can't do it

[00:39:20] like I think I can do it

[00:39:21] and so if it's a tough decision

[00:39:23] to make but you're 100% right

[00:39:24] I mean being able to do that

[00:39:26] and being able to use a systematic process

[00:39:29] can help overcome this

[00:39:30] because your overconfidence

[00:39:31] is not translating into your investment decisions.

[00:39:34] Mapping that back outputs

[00:39:37] are more important than outcomes

[00:39:38] in so many of these cases

[00:39:39] that's the only part

[00:39:40] you really have influence

[00:39:42] that you can exert over it.

[00:39:43] There's just too many variables

[00:39:45] there's too many pieces

[00:39:46] you don't even know

[00:39:47] around the table otherwise.

[00:39:49] What about the concept or idea

[00:39:52] of the sunk cost fallacy?

[00:39:55] What is that really trying to pinpoint?

[00:39:59] Well I mean I was going to stop doing this podcast

[00:40:01] but I've invested so much time in it already

[00:40:03] did I think I have no choice

[00:40:04] but to continue Matt.

[00:40:05] So I don't know if that's anything

[00:40:07] but you may want to explain

[00:40:08] the sunk cost fallacy.

[00:40:10] So the best thing is Richard Daler

[00:40:13] had on his wall apparently in his office

[00:40:16] like in the red circle

[00:40:18] with the line through it, no sunk costs

[00:40:20] and I always thought that was one

[00:40:21] of the coolest things ever.

[00:40:23] I have so basically the idea

[00:40:25] is exactly what you said.

[00:40:26] We misinterpret the things

[00:40:29] like the time, the effort

[00:40:30] the other things that we put into an event.

[00:40:33] It's the idea of once bone thugs get to LA

[00:40:37] it's the reason why they stay there for four months

[00:40:40] they're committed to the bit at this point.

[00:40:43] I have to tell you this,

[00:40:45] I'd copy this into a note here

[00:40:46] because this is like I think of this all the time

[00:40:50] and it's related to sunk cost fallacies.

[00:40:52] This is from Jason's Wig

[00:40:54] who have you guys ever had him on the show?

[00:40:56] Did you do anything with Jason's week?

[00:40:58] No we need to try something.

[00:40:59] We can yeah what a

[00:41:01] we met with him back in the day

[00:41:04] about different things

[00:41:06] but we've never had him on the podcast.

[00:41:08] All right, I'm reading this

[00:41:10] because like Connoman it's just one of those people

[00:41:13] the writing has shaped my life and career so profoundly

[00:41:16] just because of how much of it was just out there

[00:41:18] and available and he explained stuff

[00:41:20] in a way that makes it a lot of sense.

[00:41:22] So he helped Connoman in writing

[00:41:25] for thinking fast and slow

[00:41:26] and for several other projects they collaborated on.

[00:41:29] Here's a quote, there's Jason's Wig talking.

[00:41:32] Anyone who has ever collaborated

[00:41:33] with him tells a version of this story

[00:41:35] you go to sleep feeling that Danny and you had done

[00:41:37] important in contestively good work that day.

[00:41:39] You wake up at a normal human hour, grab breakfast

[00:41:42] and you open your email to your consternation

[00:41:44] you see a string of emails from Danny

[00:41:46] beginning around 2.30 AM.

[00:41:48] The subject lines commence and worry

[00:41:50] something like I don't think this works

[00:41:52] then they turn darker what were we thinking?

[00:41:54] And around 5 AM in a barrage of panic

[00:41:57] this will not do it all

[00:41:58] and then despair this is just garbage.

[00:42:01] See you send an email asking when he can talk

[00:42:03] you assume Danny must be asleep

[00:42:05] after staying up all night,

[00:42:06] trashing the chapter,

[00:42:07] your cell phone rings a few seconds later.

[00:42:09] I think I figured out the problem says Danny

[00:42:11] sounding remarkably chipper.

[00:42:13] What do you think of this approach instead?

[00:42:14] And the next thing you know he sends you a version

[00:42:17] so utterly transformed that it's unrecognizable

[00:42:19] and begins differently it ends differently

[00:42:22] and incorporates anecdotes and evidence

[00:42:24] you never would have thought of

[00:42:25] it draws on research you've never heard of

[00:42:27] if the earlier version was close to gold

[00:42:29] this one is hue and out of something like diamond

[00:42:31] the raw materials have all changed

[00:42:33] but the same ideas are somehow illuminated

[00:42:35] with a sharper shift of brilliance.

[00:42:37] The first time this happened I was thunder struck

[00:42:39] how did he do that?

[00:42:40] How could anybody do that?

[00:42:41] When I asked Danny how we could start again

[00:42:43] as if we had never written an earlier draft

[00:42:46] he said the words I've never forgotten

[00:42:47] I have no sunk costs.

[00:42:51] We get wrapped up into some stuff

[00:42:54] once we've invested time

[00:42:55] and if there's anything else

[00:42:57] it's like books like this don't happen

[00:42:58] without people going like oh maybe I was wrong

[00:43:00] about everything we did yesterday

[00:43:02] or three months ago or whatever else

[00:43:04] it's one of the hardest things to do in human life

[00:43:06] people will stay in bad uncomfortable unfortunate

[00:43:10] logic patterns, life situations and everything else

[00:43:13] just because they can't imagine to admit

[00:43:16] that one beautiful thing Justin.

[00:43:19] I was digging a hole in my backyard

[00:43:22] like last weekend and like I hit like six inches down

[00:43:25] I hit a spot that I knew I wasn't gonna be able

[00:43:27] to go anymore but I like sat there

[00:43:29] and kept digging that hole

[00:43:30] like forever like I could have easily moved

[00:43:32] to a different place where I could have dug a better hole

[00:43:34] but I was like I put my effort into digging this hole

[00:43:36] and I'm gonna dig this hole no matter what

[00:43:38] and of course I failed

[00:43:39] I couldn't dig the hole there

[00:43:41] but it's just a good example of all that

[00:43:43] anytime we put our time and effort or money

[00:43:47] or whatever into something

[00:43:48] it's like I'm into this thing

[00:43:50] it just makes me behave differently

[00:43:52] than if I thought about it as of today

[00:43:55] where I hadn't put that time and effort in

[00:43:57] I would make a different decision but again

[00:43:59] like it's great Danny has no sunk cost

[00:44:00] and he's able to do it but I am not able to do it

[00:44:02] I'm like I'm very bad at this

[00:44:04] this is probably one of the worst biases I have

[00:44:06] but this is super important too

[00:44:08] the bad sunk cost

[00:44:10] so the sunk cost

[00:44:11] the idea is I've put money, effort, time

[00:44:13] whatever into this thing

[00:44:15] the good side of it is

[00:44:19] it's an expense

[00:44:20] like you had a purpose for digging this hole presumably

[00:44:24] like this hole

[00:44:25] it's something I enjoy doing on a weekend

[00:44:26] just digging holes

[00:44:27] just digging holes

[00:44:28] somewhere between them

[00:44:30] somewhere else

[00:44:30] yeah no I did a summary to do it

[00:44:33] all right good

[00:44:33] I'm somewhere between that

[00:44:35] the money Python bit about the peasants and the soil

[00:44:37] and the dark scene of cool hand luke

[00:44:40] where you have to repeatedly dig his own grief

[00:44:44] the pattern of writing however

[00:44:46] you could also look like almost like a sunk cost

[00:44:49] it's time you invested in the act of doing this thing

[00:44:52] before you realized

[00:44:53] I just wasn't going in the right direction

[00:44:55] so exercising eating healthy

[00:44:58] all these things are also habits and trajectories

[00:45:01] we can put ourselves on that compound positively

[00:45:03] the point here is if something is compounding negatively

[00:45:06] or serving no purpose

[00:45:07] it's a cost

[00:45:08] then therefore it's something that's actually

[00:45:10] it's impacting our ability to make a better future decision

[00:45:13] on something that compounds

[00:45:15] versus something that's just a drain

[00:45:17] and as

[00:45:18] it's so real

[00:45:19] it's so in every part of our life

[00:45:21] why wouldn't it be in things like our saving strategies

[00:45:24] our investment choices or whatever else

[00:45:28] so the

[00:45:30] moving on

[00:45:31] there's this idea of

[00:45:33] people have an illusion of understanding and

[00:45:36] hindsight

[00:45:38] bias

[00:45:39] and this is the idea that

[00:45:44] you know people

[00:45:46] believe that they

[00:45:49] their understanding of the past

[00:45:52] makes sort of the future

[00:45:55] like more predictable

[00:45:56] so they have a

[00:45:57] bias towards

[00:45:58] and tell me if I'm describing this correctly

[00:46:00] they have a bias towards

[00:46:02] sort of what's happened in the past

[00:46:04] and then kind of using that to try to basically predict

[00:46:07] the future

[00:46:07] am I getting that right?

[00:46:09] This is kind of like that

[00:46:10] that idea of like I saw that coming

[00:46:12] like I think about that a lot

[00:46:13] like when I look back at 2008

[00:46:15] or whatever

[00:46:16] I could be like I saw that coming

[00:46:17] the cracks were there

[00:46:18] in the housing market

[00:46:19] and like I just knew

[00:46:21] like that was going to come

[00:46:22] where the reality is

[00:46:23] like I didn't know that

[00:46:24] and so when I translate that

[00:46:25] to the future

[00:46:26] I'm like well I see that coming now

[00:46:28] and so

[00:46:29] to me that's a good way

[00:46:30] I think they'll explain it

[00:46:31] and that you may have a better way at doing it

[00:46:33] this

[00:46:33] like these things are just also related

[00:46:35] which is part of the importance of

[00:46:37] that's why that book is that long

[00:46:38] because so many of these things do like this

[00:46:41] the

[00:46:42] so the framing effect

[00:46:43] in this idea I said at the beginning

[00:46:44] we don't make choices

[00:46:45] between things

[00:46:46] we make choices

[00:46:46] between descriptions of things

[00:46:48] so Jack would you qualify

[00:46:49] like thinking you saw a crash coming

[00:46:52] or thinking you thought

[00:46:53] a value investing would work

[00:46:55] in the period after 2008 2009

[00:46:58] the way it did 2001 through 2003

[00:47:02] you were creating an analog

[00:47:03] in your head

[00:47:04] for how you would think

[00:47:05] through those things

[00:47:06] that affair

[00:47:07] and yeah

[00:47:07] somebody else

[00:47:08] that's right

[00:47:09] okay

[00:47:10] so this idea

[00:47:11] is very different than how I actually thought about it

[00:47:12] like at the time

[00:47:13] you know

[00:47:14] I'm going back

[00:47:15] and like looking at it

[00:47:15] but it's certainly not the way

[00:47:16] if I thought about these things

[00:47:17] that way at the time

[00:47:18] that would have been like sure everything in 2008

[00:47:20] and you know

[00:47:21] yeah

[00:47:22] I wouldn't be talking on this podcast

[00:47:23] probably I said the unsome island somewhere

[00:47:25] there you go

[00:47:26] so we put

[00:47:27] we actively put a frame around stuff

[00:47:29] and this is a really important thing to understand

[00:47:32] that act of

[00:47:33] we have to make a choice

[00:47:34] we have to put a frame around it

[00:47:35] we have to understand

[00:47:36] the puzzle pieces are on the table in the frame

[00:47:39] and then we're going to attribute

[00:47:40] different things in and out of the frame

[00:47:41] to help make sense of it

[00:47:43] this is just

[00:47:44] how we decide

[00:47:45] it's not good or bad

[00:47:46] or right or wrong

[00:47:47] it's just an inherent thing

[00:47:48] and other people will try to put stuff into our heads

[00:47:51] that'll influence influence the stuff too

[00:47:54] so

[00:47:55] there was

[00:47:56] did you guys stay current on

[00:47:58] on condom's work

[00:47:59] like did you follow him to his work about noise

[00:48:01] in this concept too

[00:48:04] I

[00:48:05] um

[00:48:06] I

[00:48:07] yeah yes I was following

[00:48:09] but I kind of forget what that was

[00:48:11] was like trying to tune out the noise

[00:48:13] type thing

[00:48:14] so

[00:48:16] this was a pretty profound

[00:48:18] thought there's definitely

[00:48:20] there was a Tyler Cowan interview

[00:48:21] there's a whole book on this

[00:48:22] but there's a Tyler Cowan interview in particular

[00:48:24] that I went back and found some notes on

[00:48:26] from

[00:48:27] probably like 2019 or 20

[00:48:29] on coldest creative summer

[00:48:31] but it's

[00:48:32] this idea that bias has been overestimated

[00:48:34] at the expensive noise

[00:48:36] and something he points out

[00:48:37] and this is important for when we're thinking about framing stuff

[00:48:40] it's that when we're looking at bias

[00:48:42] we're looking for causal relationships

[00:48:45] so we're looking for like this causes that

[00:48:47] stocks go down value goes up because we miss

[00:48:51] we miss value

[00:48:53] tangible assets or something like that which are actually worth more

[00:48:55] when we're trying to recover and blah blah blah blah

[00:48:58] but while we're looking at noise

[00:48:59] we're looking at these statistical relations

[00:49:02] so

[00:49:02] this correlates with that

[00:49:04] well yeah

[00:49:05] stuff tends to go up after it goes down a lot

[00:49:07] there's a correlation between why these things happen

[00:49:10] that difference between

[00:49:12] if I am a causal relationship

[00:49:15] I'm looking at biases and when I have a

[00:49:18] statistical relationship correlations

[00:49:20] I'm looking at noise becomes

[00:49:22] really important that we don't confuse these two things

[00:49:26] so

[00:49:27] just looking at statistics

[00:49:29] just with like the value investor

[00:49:30] the quantum investor had on

[00:49:32] we have to be careful

[00:49:33] that just because there's causal relationships

[00:49:36] they're not actually always useful

[00:49:39] for

[00:49:40] you know proven causality

[00:49:41] I'm thinking about some of the AI things

[00:49:44] and other stuff we've talked about or

[00:49:46] what was that paper where the guys were basically like

[00:49:48] none of the explanations of any of the factors matter

[00:49:51] like anything that correlates is useful

[00:49:54] what was that episode or that paper you guys talk about

[00:49:56] there was Andrew Shannon Ollyhunder Lopez Lira

[00:49:58] yeah that's where they looked at like all the factors

[00:50:00] basically and they found that the ones that didn't have

[00:50:03] explanations that we couldn't explain to just as well

[00:50:05] as the ones that we could explain

[00:50:07] which sort of challenges a lot of the finance theory

[00:50:09] we have out there

[00:50:11] so again like bias has been overestimated at the expensive noise

[00:50:15] and that's the big statement he comes with in this whole book

[00:50:19] and this whole body of work

[00:50:20] and understanding that understanding data that's causal

[00:50:25] and understanding the understanding data

[00:50:26] that's correlated are two different things

[00:50:28] we have to talk about them differently

[00:50:30] just likely talked about system one and two

[00:50:32] and we as humans are just a mess

[00:50:34] as we interlope between these two things

[00:50:38] well and I think you can definitely be

[00:50:40] I think like the media can take advantage of that

[00:50:42] and sort of use the correlated noise

[00:50:47] to try to influence or

[00:50:53] you know inform people that might not be necessarily

[00:51:01] not in their best interests

[00:51:02] that's not what I'm trying to say

[00:51:03] it's just you know they maybe

[00:51:05] there might be too much noise

[00:51:07] is what I'm really trying to say

[00:51:09] it's brilliant to present noise as signal

[00:51:12] and present noise as something that's causal

[00:51:15] like it's this thing of you know if I'm thinking

[00:51:19] of that Spurious correlations website

[00:51:21] which I absolutely love an adored hope still exists

[00:51:23] where you could say does the rain in New Zealand correlate

[00:51:27] with like Nicolas Cage movies or something

[00:51:30] and it's this idea that just because the correlation

[00:51:32] is there doesn't mean there's a causal relationship

[00:51:35] between these two things

[00:51:36] and yes we see this all the time in media

[00:51:38] we see this all the time with politicians

[00:51:41] and people saying like here's this story over here

[00:51:44] and I'm going to tell you a causally

[00:51:45] represents this thing over there

[00:51:48] doesn't mean it's always right

[00:51:49] doesn't mean it's always wrong

[00:51:51] just means if we can be aware of it

[00:51:52] and talk about it happening

[00:51:55] it's a lot easier to be humans

[00:51:57] when we can

[00:51:59] admit we're not all perfect rational actors

[00:52:01] to take it back to that idea Jack

[00:52:03] that reminds me of the whole thing

[00:52:04] of a butter production in Bangladesh

[00:52:06] and the S&P 500

[00:52:07] like I think some people showed there was some correlation

[00:52:10] there between those two things

[00:52:12] but there certainly wasn't any causation

[00:52:15] I am totally going to spend some quality time

[00:52:17] on the Spurious correlations website after this

[00:52:19] just because I miss making bold claims

[00:52:22] like that you know at cocktail parties

[00:52:26] so yeah so in the spirit of Danny Conman

[00:52:28] I'm gonna recommend that we

[00:52:30] or suggest we try to talk about this stuff

[00:52:33] at least once a year because there's a lot here

[00:52:36] we talked about system one and two

[00:52:37] talked about anchoring

[00:52:40] the availability heuristic

[00:52:42] prospect theory over confidence

[00:52:45] framing

[00:52:46] hindsight bias

[00:52:48] I mean these are all things that we could probably

[00:52:50] you know have full episodes on

[00:52:52] we've really just scratched the surface of it

[00:52:54] but Matt I want to say I think you did a great job

[00:52:57] of kind of walking us through these

[00:52:59] helping us understand

[00:53:00] because

[00:53:01] and your point earlier is really good

[00:53:03] like a lot of these are

[00:53:05] they're sort of like joined together in different ways

[00:53:08] and you almost can't talk about one

[00:53:10] without talking about the other

[00:53:11] and there's a really good like framework here

[00:53:15] for trying to improve decision-making

[00:53:18] that I think all investors

[00:53:20] well individual investors and professionals

[00:53:22] can certainly learn from

[00:53:23] so we appreciate you guys

[00:53:26] watching

[00:53:28] we'll certainly miss Daniel Conman's work

[00:53:32] and our condolences to his family

[00:53:35] and we will see you next time guys

[00:53:37] thank you see you at the Crossroads

[00:53:38] Mr. Coderman thank you

[00:53:40] hi guys this is Justin again

[00:53:42] thanks so much for tuning into this episode

[00:53:45] you can follow Jack on Twitter at

[00:53:47] practical quaint

[00:53:48] you can follow me on twitter at

[00:53:49] jj carbono

[00:53:50] and follow Matt on twitter at

[00:53:52] cultish creative

[00:53:54] if you found this discussion interesting and valuable

[00:53:56] please subscribe and either iTunes

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[00:53:59] or leave a review or a comment

[00:54:01] also if you have any ideas for topics you'd like us to cover in the future

[00:54:05] please email us at accessforturnspod at gmail.com

[00:54:08] we would like this to be a listener driven podcast

[00:54:11] and would appreciate any suggestions thank you