by Tom Brakke, Research Puzzle
Seth Klarman once said, âYou need to balance arrogance and humility . . . when you buy anything, itâs an arrogant act.â However, âyou need the humility to say âbut I might be wrong.â And you have to do that on everything.â
Or, as Barbara Krugerâs installation at the Hirshhorn Museum in Washington, D.C. yells out in bold letters:Â âBELIEF + DOUBT = SANITY.â
Itâs important to note that without a certain amount of confidence, we wouldnât get very far. As individuals thatâs true and the same goes for organizations. We are in the business of taking risks, and having the confidence to do so is an essential part of the recipe for success. But how much of it is warranted? A dash, a smidgen, a dollop?
Unfortunately, we know from research study after research study that we invariably get beyond a reasonable level, into âoverconfidence.â And then we make poor decisions.
Daniel Kahnemanâs Thinking, Fast and Slow delved into that âpuzzling limitation of our mind: our excessive confidence in what we believe we know, and our apparent inability to acknowledge the full extent of our ignorance and the uncertainty of the world we live in.â In fact, to bring it closer to home, Kahneman repeatedly referenced investment forecasting as an endeavor that is particularly susceptible to overconfidence bias because those tendencies are such a mismatch with the workings of markets.
But we donât let that stop us. âThe confidence that individuals have in their beliefs depends mostly on the quality of the story that they can tell about what they see, even if they see very little,â Kahneman wrote. Your feeling about something â your confidence in it â âis determined by the coherence of the best story that you can tell from the evidence at hand.â
Because even âpoor evidence can make a very good story,â we persist in making forecasts even when we shouldnât. To complicate matters, âoptimism is highly valued, socially and in the market; people and firms reward the providers of dangerously misleading information more than they reward truth tellers.â
Therefore, revealing doubt and demonstrating humility are unnatural (and dangerous) acts for us. They should serve as our de facto starting points for analysis and communication, but if we tell everyone how much we donât know, will they listen to our story?
Most definitions of âconfidence gameâ reference a swindler defrauding a victim after the the victimâs trust has been won. Unfortunately, there are some outright swindlers in the investment world, and there are those whose stories are embellished enough to have clearly crossed the line into manipulation.
That said, the majority of us go about our business with good intentions, though we carry the baggage that Kahneman described. We are behaviorally disposed to overconfidence by our very nature â and, hereâs the kicker â the norms and incentives of the organizations that we are part of (and those that we do business with) push us further in that direction.
Twenty years ago, Kahnemanâs research partner Amos Tversky told a group of investment professionals, âTime and time again, we learn that our overconfidence leads to bad decisions, so recognizing our limited ability to predict the future is an important lesson to learn.â
Have we taken those lessons to heart? For the most part, no.
We continue to play the confidence game. We havenât designed our organizations to dampen our predilection for overconfidence. In fact, they often exacerbate it.
True progress will be made when the findings of Kahneman and Tversky (and others) arenât just fodder for popular books, but actually change how decisions are made.
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