WEBVTT - Interview With Daniel Kahneman: Masters in Business (Audio) 0:00:03.240 --> 0:00:07.600 This is Masters in Business with Barry Ridholds on Bloomberg Radio. 0:00:08.280 --> 0:00:12.160 This week on the show, I have an extra special guest. 0:00:12.640 --> 0:00:14.240 I know you guys give me grief for saying that 0:00:14.280 --> 0:00:17.360 every week, but I really have an extra special guest, 0:00:17.800 --> 0:00:21.680 Professor Danny Kahneman, winner of the two thousand and two 0:00:21.760 --> 0:00:25.440 Nobel Prize in Economics, which is quite a feat when 0:00:25.480 --> 0:00:29.720 you realize that he's not an economist. He's a cognitive psychologist, 0:00:30.160 --> 0:00:33.640 author of the book Thinking Fast and Slow before we 0:00:33.720 --> 0:00:37.760 get to the podcast, which is really quite fascinating. Just 0:00:37.840 --> 0:00:42.480 a quick funny story. So we finished doing the interview 0:00:42.800 --> 0:00:46.080 and we're heading out of the Bloomberg building where you're 0:00:46.080 --> 0:00:48.520 heading to, Oh, I'm going over here. Oh I'm heading 0:00:48.520 --> 0:00:51.519 in that same direction, I tell Danny, which is what 0:00:51.560 --> 0:00:54.280 he insists everybody call him. And so we take a 0:00:54.280 --> 0:00:57.800 subway downtown and we're get out at Grand Central and 0:00:57.800 --> 0:01:01.600 we're walking someplace and and he said, as to me, listen, 0:01:01.600 --> 0:01:03.120 you don't have to walk me to where I'm going. 0:01:03.280 --> 0:01:05.440 I'm in New York right now where I am? And 0:01:05.480 --> 0:01:07.959 I said, well, to tell you the truth, it's two o'clock. 0:01:08.080 --> 0:01:11.440 I haven't had lunch yet. A block from where your 0:01:11.480 --> 0:01:16.720 destination is. Is this lovely um sandwich shop called Alidoro, 0:01:17.360 --> 0:01:20.320 just open the midtown. There's a Soho branch. It's really good. 0:01:20.959 --> 0:01:25.280 I'm just heading in your direction anyway. So he looks 0:01:25.319 --> 0:01:28.160 at me and says, the sandwich is really that good. Yes, 0:01:28.200 --> 0:01:32.920 they're delicious. So long story short, we go into this place. 0:01:33.000 --> 0:01:36.880 It's essentially a takeout joint with one long picnic table 0:01:36.880 --> 0:01:42.120 on the back. Most people um take sandwiches out. And 0:01:42.240 --> 0:01:46.199 it's two o'clock so the rush lunch hour rush is over, 0:01:46.680 --> 0:01:49.960 so I we order sandwiches. Takes a few minutes. I 0:01:50.040 --> 0:01:52.120 kind of put it, sit him down at the table, 0:01:52.680 --> 0:01:55.880 and I said, I'll go get the sandwiches. And as 0:01:55.880 --> 0:02:00.440 I'm coming back to the table, there is Professor Khneman 0:02:00.560 --> 0:02:04.600 sitting at a picnic table surrounded by I don't know 0:02:04.960 --> 0:02:08.840 a dozen millennials, kids who could have been in his 0:02:09.040 --> 0:02:13.040 class a couple of years ago at Princeton, and they're 0:02:13.120 --> 0:02:19.399 just holy oblivious to this kindly professor sitting amongst them. 0:02:19.720 --> 0:02:24.200 Here's a brilliant thinker who changed the way we think 0:02:24.280 --> 0:02:30.440 about how we think, and just everybody completely wholly unaware 0:02:31.080 --> 0:02:34.320 that that brilliance is in their midst. Then it's the 0:02:34.360 --> 0:02:38.280 whole thing just cracked me up. I found the interview 0:02:38.320 --> 0:02:41.400 to be absolutely fascinating. I think you will also, so, 0:02:41.560 --> 0:02:48.840 with no further ado, my conversation with Danny Khneman. This 0:02:49.160 --> 0:02:53.120 is Masters in Business with Barry Ridholts on Bloomberg Radio. 0:02:53.760 --> 0:02:56.240 Our special guest this week. And I know I say 0:02:56.240 --> 0:02:59.120 this all too often, but we really do have an 0:02:59.120 --> 0:03:03.680 extra special us this week. His name is Professor Daniel Kaneman. 0:03:04.000 --> 0:03:07.440 He taught at the Woodrow Wilson School at Princeton, both 0:03:07.440 --> 0:03:11.600 in psychology and public affairs. He is a fellow at 0:03:11.639 --> 0:03:15.880 the Center for Rationality at Hebrew University, winner of the 0:03:15.960 --> 0:03:20.920 Nobel Prize in Economic Sciences as well as the Lifetime 0:03:21.080 --> 0:03:27.079 Contribution Award of the American Psychology Association UH and he 0:03:27.200 --> 0:03:30.600 is a recipient of the Presidential Medal of Freedom. I 0:03:30.639 --> 0:03:33.320 could go on and on about his curriculum vita, but 0:03:33.400 --> 0:03:36.400 I would rather jump right into this. Danny Kahneman, Welcome 0:03:36.440 --> 0:03:40.280 to Bloomberg. Pleased to be here, so I'm excited to 0:03:40.360 --> 0:03:44.240 talk to you about so many different things. Let's let's 0:03:44.440 --> 0:03:47.839 start way back at the beginning. You you began your 0:03:47.920 --> 0:03:52.440 academic career in Israel. Did did you expect to spend 0:03:52.960 --> 0:03:56.120 the rest of your life working in academia? Oh? Yeah, 0:03:56.240 --> 0:03:59.320 I mean I expected to be a professor when I 0:03:59.400 --> 0:04:03.120 was a kid. And so you win the Nobel Prize 0:04:03.120 --> 0:04:06.760 in two thousand and two, not for psychology, which is 0:04:06.840 --> 0:04:09.760 your field of study, but but for economics. How does 0:04:09.800 --> 0:04:12.480 the psychologist win a prize for economics? Well, I mean 0:04:12.520 --> 0:04:16.280 there is no Nobel in psychology, but we wanted in 0:04:16.360 --> 0:04:22.160 economics for work that is psychological. Uh, when it's you 0:04:22.320 --> 0:04:25.720 and he didn't actually win this because they don't give 0:04:25.720 --> 0:04:29.159 it posthumously, but you know, I always felt it it's 0:04:29.160 --> 0:04:34.159 a joint prize because the prize was awarded for work 0:04:34.200 --> 0:04:38.880 we had done together, and it was work that influenced economics. 0:04:38.960 --> 0:04:42.920 So it's under influence in general that you get a Nobel, 0:04:43.040 --> 0:04:45.840 not on the quality of the work necessary. So so 0:04:45.960 --> 0:04:50.640 let's talk about your colleague, a most diverse key in 0:04:50.800 --> 0:04:54.760 your book Thinking Fast and Slow, you described first seeing 0:04:54.839 --> 0:04:58.359 him speak. I think it was around nineteen sixty nine 0:04:58.480 --> 0:05:03.279 and the subject was, uh, do people make good intuitive 0:05:03.400 --> 0:05:07.320 statistical assumptions? Did you know right away the two of 0:05:07.320 --> 0:05:11.240 you were destined to be research partners? No? But what 0:05:11.360 --> 0:05:15.080 happened was he visited seminario was teaching. I mean I 0:05:15.160 --> 0:05:19.039 invited him and he spoke about some research that was 0:05:19.120 --> 0:05:23.960 being done in Michigan at the time on whether people 0:05:23.960 --> 0:05:27.640 are good intuitive statisticsians, and their conclusion was that they are. 0:05:28.360 --> 0:05:32.920 And so we had very counterintuitive well it's now counterintuitive, 0:05:33.000 --> 0:05:36.440 at that time, it sounded quite intuitive, and we had 0:05:36.480 --> 0:05:39.880 a very heated discussion. You know, they had those in Israel, 0:05:40.040 --> 0:05:44.640 and it was a very Israeli type conversation and we 0:05:44.800 --> 0:05:47.520 enjoyed it, both of us. We decided to have lunch 0:05:47.600 --> 0:05:52.920 together the following Friday, and there we we discussed ideas 0:05:53.000 --> 0:05:55.680 over that lunch, and we didn't know that it was 0:05:55.720 --> 0:05:57.960 going to shape our lives, but we had a pretty 0:05:57.960 --> 0:06:01.280 good inkling of what we wanted to do next. So 0:06:01.960 --> 0:06:07.800 the two you established a cognitive basis for analyzing common 0:06:08.040 --> 0:06:13.279 human errors and how they arrive from biases. How did you, guys, 0:06:13.360 --> 0:06:18.400 happen across across that discovery. We started, you know, from 0:06:18.400 --> 0:06:21.240 a combination of what Amos knew and what I was 0:06:21.320 --> 0:06:26.200 specialized in, and my specialty at the time was visual perception, 0:06:26.920 --> 0:06:31.279 and in visual perception you have illusions and analyzing the 0:06:31.320 --> 0:06:35.559 illusions is interesting because the illusions teach you something about 0:06:35.560 --> 0:06:40.720 the mechanism of normal perception. And Amos was an expert 0:06:40.800 --> 0:06:45.279 on decision theory and on formal analysis, and we complemented 0:06:45.320 --> 0:06:50.239 each other very well. And the idea that the research 0:06:50.320 --> 0:06:53.640 that we developed eventually was really a research on cognitive 0:06:53.680 --> 0:06:58.080 illusions and where they come from. And we proposed a 0:06:58.120 --> 0:07:03.039 mechanism and mechanisms we call we call those heuristics, and 0:07:03.120 --> 0:07:07.279 now have a somewhat different interpretation, not very different, but 0:07:07.440 --> 0:07:10.440 slightly different from the one we had at that time. 0:07:10.680 --> 0:07:14.640 I mean, the general idea is quite simple. You ask 0:07:14.720 --> 0:07:18.240 people a complicated question like what is the probability of 0:07:18.280 --> 0:07:23.080 an event? And they can't answer it because it's very difficult. 0:07:23.720 --> 0:07:26.600 But there are easier questions that are related to that 0:07:26.640 --> 0:07:30.600 one that they can answer, such as, this is a 0:07:30.680 --> 0:07:34.600 surprising event that is something that people know right away? 0:07:35.200 --> 0:07:38.920 Is it a typical result of that kind of mechanism? 0:07:39.240 --> 0:07:43.080 And people can answer that right away. So, and what 0:07:43.240 --> 0:07:46.679 happens is people take the answer to the easy question, 0:07:47.360 --> 0:07:51.080 they use it to answer the difficult question, and they 0:07:51.160 --> 0:07:54.480 think they have answered the difficult question. In fact, they haven't. 0:07:54.720 --> 0:07:57.560 They answered an easier one. So that's why the mechanism 0:07:57.600 --> 0:08:01.640 that we studied. You mentioned that your view on heuristics 0:08:01.680 --> 0:08:06.120 have changed somewhat over the years. What's the difference between 0:08:06.120 --> 0:08:09.480 what you live today and and way back when. Well, 0:08:10.080 --> 0:08:13.200 we started out with what we call a limited number 0:08:13.240 --> 0:08:17.680 of heuristics, and they became quite well known because we 0:08:17.760 --> 0:08:22.200 have a paper that we published in nine four that 0:08:22.760 --> 0:08:25.560 in we published it in Science magazine, so it was 0:08:25.640 --> 0:08:30.360 widely read across many disciplines. And in that paper we 0:08:30.440 --> 0:08:34.839 spoke about three major heuristics, and we analyze the biases 0:08:35.240 --> 0:08:38.760 that these heuristics lead to. And many people would know 0:08:38.840 --> 0:08:41.319 their name from if they went to business school. So 0:08:41.720 --> 0:08:48.640 it's representativeness, it's availability and anchoring. What I'm thinking of 0:08:48.840 --> 0:08:51.720 now is that there is a more general process, and 0:08:51.800 --> 0:08:55.120 that's the process I described a minute ago. They called 0:08:55.160 --> 0:08:59.920 that attribute substitution. It's to substitute one question for another's. 0:09:00.000 --> 0:09:03.640 So instead of answering the complex, difficult question, you answer 0:09:03.679 --> 0:09:06.440 what you can, which is the easier question. That's right. 0:09:06.520 --> 0:09:09.440 So if I ask you an example that comes to mind, 0:09:09.679 --> 0:09:13.080 how happy are you these days? Now? You know your 0:09:13.120 --> 0:09:16.600 mood right now? You're very likely to tell me your 0:09:16.640 --> 0:09:19.600 mood right now. And think that you have answered the 0:09:19.720 --> 0:09:22.440 more general question of how happy are you these days? 0:09:22.840 --> 0:09:25.880 So that's that's another example. There are many like them. 0:09:26.120 --> 0:09:29.400 I'm Barry Ridholts. You're listening to Masters in Business on 0:09:29.440 --> 0:09:33.800 Bloomberg Radio. My special guest today is Nobel Prize winning 0:09:33.840 --> 0:09:38.880 psychologist Danny Kahneman, who has specialized in both cognitive and 0:09:38.960 --> 0:09:42.880 decision making processes. Let's let's jump right into some of 0:09:42.880 --> 0:09:46.480 the things that you discussed in Thinking Fast and Slow, 0:09:46.800 --> 0:09:50.800 a book that I found to be just right in 0:09:50.880 --> 0:09:54.000 the sweet spot of my confirmation bias. Who was everything 0:09:54.320 --> 0:09:57.559 I hoped it to be. You talked about what you 0:09:57.600 --> 0:10:01.360 see is all there is? When when this cussing systems 0:10:01.360 --> 0:10:04.240 one and two, it's almost a theme throughout the book, 0:10:04.679 --> 0:10:07.920 explain what that is? What you see is all there is? Well, 0:10:08.200 --> 0:10:12.320 people are really not aware of information that they don't have, 0:10:13.320 --> 0:10:17.160 and so the the idea which is emphasized in the 0:10:17.240 --> 0:10:21.000 book is that you take whatever information you have and 0:10:21.040 --> 0:10:24.000 you make the best story possible out of that information. 0:10:24.640 --> 0:10:27.880 And the information you don't have you don't feel that 0:10:27.920 --> 0:10:31.400 it's necessary. And I have an example that that I 0:10:31.440 --> 0:10:34.559 think brings that out. If I tell you about a 0:10:35.040 --> 0:10:42.800 national leader, that she is intelligent and firm. Now do 0:10:42.840 --> 0:10:45.360 you have an impression already whether she's a good leader 0:10:45.440 --> 0:10:48.440 or a bad leader, And you certainly do. She's a 0:10:48.480 --> 0:10:51.040 good leader. Now the third word that I was about 0:10:51.080 --> 0:10:56.280 to say is corrupt. But you know, the point being 0:10:56.720 --> 0:11:00.079 that you didn't wait for information that you didn't have, 0:11:00.800 --> 0:11:03.800 who formed an impression as we were going with the 0:11:03.840 --> 0:11:07.200 information you did have, And this is what you see, 0:11:07.240 --> 0:11:10.640 is all there is the working assumption amongst people who 0:11:10.640 --> 0:11:14.600 are trying to draw a conclusion from available information is 0:11:15.080 --> 0:11:19.200 they failed to calculate the impact of data they're either 0:11:19.320 --> 0:11:23.120 unaware of, or don't know or simply haven't encountered. That's 0:11:23.520 --> 0:11:26.559 I mean, people, If what people are trying to do 0:11:26.679 --> 0:11:29.520 is to make the best story possible out of the 0:11:29.559 --> 0:11:32.520 information they have, then this is what they're going to do. 0:11:32.559 --> 0:11:37.280 And that the measure of confidence that people have in uh, 0:11:37.360 --> 0:11:40.440 in their beliefs, in their opinions, there's really a reflection 0:11:40.480 --> 0:11:43.760 of the quality of the story that they've told them. So, 0:11:43.760 --> 0:11:46.679 so let's talk about that narrative because it's it's one 0:11:46.760 --> 0:11:50.720 of my favorite errors in investing is that we tell 0:11:50.760 --> 0:11:57.199 ourselves these complex narratives that seem to fit whatever information 0:11:57.280 --> 0:12:00.840 is in front of us, and that very much creates 0:12:00.880 --> 0:12:05.560 a risk that the narrative, as emotional and compelling as 0:12:05.600 --> 0:12:09.200 it might be, is possibly misleading. How does that fit 0:12:09.240 --> 0:12:12.920 into your work? I think the same. Talib has a 0:12:13.040 --> 0:12:16.960 very nice example in his in his book The Black Swan. 0:12:17.559 --> 0:12:21.880 It's an example of that happened at Bloomberg on Bloomberg News, 0:12:22.840 --> 0:12:27.040 and it happened the day that Saddam was court, and 0:12:27.520 --> 0:12:30.920 something happened in the bond market shortly thereafter. I forget 0:12:30.920 --> 0:12:34.200 whether it rose or it felt and the headline was 0:12:35.040 --> 0:12:40.320 Saddam Court and investors are fleeing from risk. And then 0:12:40.400 --> 0:12:44.160 a few hours later the market reversed and there was 0:12:44.160 --> 0:12:49.280 a headline that said, Saddam Court investors feel more secure 0:12:49.360 --> 0:12:54.840 taking risk. So now what happened was obviously it's not 0:12:54.960 --> 0:12:59.920 plausible that that you could explain to opposite consequences by 0:13:00.040 --> 0:13:02.319 the same thing, but you can make a very good 0:13:02.360 --> 0:13:06.840 story and what happens and commentators and Bloomberg Radio and 0:13:07.000 --> 0:13:11.440 all other pundits what they do there is a salient 0:13:11.480 --> 0:13:15.200 event today. So when you're looking at what happened in 0:13:15.240 --> 0:13:19.120 the market, you're looking back and you see that salient event, 0:13:19.280 --> 0:13:23.200 and irresistibly you think there is a causal connection. So 0:13:23.400 --> 0:13:26.840 whatever happened in the market you attribute to the salient event, 0:13:26.880 --> 0:13:31.160 went up, went down, whatever it's always it makes a 0:13:31.240 --> 0:13:35.440 good story. I have a very vivid recollection early in 0:13:35.480 --> 0:13:40.640 the two thousand and three Iraq invasion there was a important, 0:13:40.800 --> 0:13:45.960 highly regarded mosque that was blown up by American warplanes. 0:13:46.040 --> 0:13:48.280 And the headline, and I don't remember it was the 0:13:48.320 --> 0:13:49.840 Times of the Wall Street Journal, but it was a 0:13:49.880 --> 0:13:56.839 big publication oil prices skyrocket on mosque accidentally being blown up. 0:13:56.920 --> 0:14:00.000 And later that day, so you're looking at this online 0:14:00.040 --> 0:14:03.439 and later that day the oil prices had come back down, 0:14:03.920 --> 0:14:06.839 and it was the same headline, only changing the conclusion 0:14:07.400 --> 0:14:11.560 mass destroyed, oil prices remains stable. Well, if it's going 0:14:11.640 --> 0:14:15.040 up and down after the event, it means the event 0:14:15.160 --> 0:14:19.000 isn't really significant, is it? Well, clearly. So let's talk 0:14:19.040 --> 0:14:21.680 a little bit about some of the biases, those three 0:14:21.680 --> 0:14:27.920 biases you discovered early on availability, anchoring, and representativeness. First, 0:14:28.320 --> 0:14:34.440 these are three enormous biases. First question, why publish in 0:14:34.520 --> 0:14:38.760 Discover magazine or Science magazine as opposed to some staid 0:14:39.040 --> 0:14:42.680 academic journal. Oh, we had done our homework. I mean 0:14:42.760 --> 0:14:47.560 we published in State academic journalist first, and then what 0:14:47.720 --> 0:14:51.720 we published in Science, which you know is a scientific magazine. 0:14:51.760 --> 0:14:55.240 I mean it's not it's a popular magazine. No it's not. No, 0:14:55.360 --> 0:14:58.960 it's a it's a Science is a professional magazine, but 0:14:59.240 --> 0:15:04.840 it's a it's addressed to scientists of all disciplines. But 0:15:05.040 --> 0:15:09.240 you know, it's a it's a perfectly respectable scientific magazine. No, 0:15:09.400 --> 0:15:13.840 we did. We we were academics. We published academically. We 0:15:13.920 --> 0:15:17.560 didn't publish and discover. They looked us up and they 0:15:17.560 --> 0:15:21.760 interviewed us and they wrote about us, but we didn't 0:15:21.760 --> 0:15:24.880 seek that out. We were really academics. We were not 0:15:24.960 --> 0:15:29.360 trying to influence the world. And whatever happened happened, but 0:15:29.760 --> 0:15:33.000 that wasn't really what we intended. Did you have any 0:15:33.120 --> 0:15:38.640 sense of the enormity of these three particular biases early on, Well, 0:15:38.680 --> 0:15:42.840 when we wrote for Science, we had a sense that 0:15:42.880 --> 0:15:47.120 this was an important story. We really did not anticipate 0:15:47.200 --> 0:15:51.760 the impact that it had on many fields, including investment 0:15:51.880 --> 0:15:56.240 and the law, and and and even economics. It had 0:15:56.640 --> 0:16:00.000 a lot of influence and that we didn't anticipate. Really. 0:16:00.160 --> 0:16:01.960 So so let's talk about a couple of these. You 0:16:02.360 --> 0:16:07.520 mentioned availability bias, it's just the information you have. Anchoring 0:16:07.800 --> 0:16:12.800 is an enormous factor in things like negotiations, in pricing. 0:16:13.280 --> 0:16:16.680 I love the story of just asking people. Ask a 0:16:16.680 --> 0:16:19.440 group of people in a room what the first digit 0:16:19.600 --> 0:16:22.560 of their phone number is, and then ask them a separate, 0:16:22.640 --> 0:16:27.000 unrelated question. A higher digit will yield a higher number 0:16:27.040 --> 0:16:30.080 on the unrelated question, and a lower first digit yields 0:16:30.080 --> 0:16:33.400 a low How did how did that discovery come about? Well, 0:16:33.440 --> 0:16:37.240 actually it takes a little more than that, but I'll 0:16:37.280 --> 0:16:41.320 give you an example. Uh, in the example of negotiation, 0:16:41.880 --> 0:16:45.040 many people think that you have an advantage if you 0:16:45.120 --> 0:16:49.480 go second, but actually the advantage is going first throughout 0:16:49.520 --> 0:16:52.520 the first number, and that's where you're throughout. And and 0:16:52.560 --> 0:16:56.160 the reason is something in the way the mind works. 0:16:56.840 --> 0:17:00.400 And the mind works, it tries to make sense whatever 0:17:00.480 --> 0:17:04.760 you put before it. So this built in tendency that 0:17:04.800 --> 0:17:07.439 we have of trying to make sense of everything that 0:17:07.480 --> 0:17:12.800 we encounter, that is a mechanism for anchoring. I'm Barry Ridholts. 0:17:12.920 --> 0:17:16.359 You're listening to Masters in Business on Bloomberg Radio. My 0:17:16.440 --> 0:17:21.320 special guest today is Nobel Prize winning psychologist Danny Kahneman, 0:17:21.359 --> 0:17:26.080 who has specialized in both cognitive and decision making processes. 0:17:26.640 --> 0:17:29.200 Let's talk a little bit about biases and money. Since 0:17:29.320 --> 0:17:32.880 this is Bloomberg and many of our listeners are investors, 0:17:33.200 --> 0:17:36.040 I want to start with prospect theory, which is something 0:17:36.040 --> 0:17:39.960 that's I find absolutely fascinating. The basic idea is that 0:17:40.000 --> 0:17:44.760 we feel losses much more severely than we enjoy gains. 0:17:45.280 --> 0:17:47.639 The first question I have for you about this is 0:17:48.119 --> 0:17:51.800 how did you discover this? Well, the idea that came 0:17:51.840 --> 0:17:57.960 first or the was that the standard financial analysis and 0:17:58.080 --> 0:18:03.080 which called the rational age model, fails in an important way. 0:18:03.520 --> 0:18:06.560 And in the rational agent model, you should always be 0:18:06.640 --> 0:18:09.560 thinking in terms of wealth. You know, what will be 0:18:09.640 --> 0:18:12.280 my wealth if this happens? What will be my wealth 0:18:12.320 --> 0:18:15.639 if that happens? And all the theory is based on 0:18:15.720 --> 0:18:19.159 the idea that you are thinking in terms of your wealth. 0:18:19.400 --> 0:18:21.320 But it turns out you're not thinking in terms of 0:18:21.359 --> 0:18:23.720 your wealth at all. You're thinking in terms of gains 0:18:23.720 --> 0:18:26.760 and losses. You're thinking in terms of changes of wealth. 0:18:27.200 --> 0:18:30.400 So that was the first thing that that was important 0:18:30.440 --> 0:18:34.800 to establish. It was clear Homo economists is what the 0:18:34.800 --> 0:18:38.280 professors call it, not a really good representation of how 0:18:38.359 --> 0:18:41.040 people behave. That's right, and you know that this is 0:18:41.080 --> 0:18:44.200 sort of immediately obvious that people don't think in terms 0:18:44.280 --> 0:18:47.359 of their wealth. And it's easy to show that that 0:18:47.480 --> 0:18:52.200 they don't because you can describe the same decision which 0:18:52.240 --> 0:18:54.360 in the same in terms of wealth. You can give 0:18:54.400 --> 0:18:57.720 it two different descriptions and people will make different choices 0:18:58.080 --> 0:19:02.320 depending on whether it's resented in gains and losses. So 0:19:02.400 --> 0:19:05.320 that were the first discovery, if you will, I mean, 0:19:05.400 --> 0:19:08.400 you know it had been stated before by the way 0:19:08.680 --> 0:19:13.080 Marco Witch Harry Marco which he had he had written. 0:19:13.440 --> 0:19:18.080 He had written one article on this about changes being important. 0:19:18.160 --> 0:19:21.720 He didn't follow through, and we came upon us and 0:19:21.840 --> 0:19:24.760 we did follow through. Now, once you have that that 0:19:24.840 --> 0:19:27.920 people are thinking gains and losses, it's easy to see 0:19:27.960 --> 0:19:31.760 that there is an asymmetry. That is that losses, as 0:19:31.800 --> 0:19:36.320 we said, loom larger than gains. And we even have 0:19:36.400 --> 0:19:39.600 a pretty good idea of by how much do they 0:19:39.640 --> 0:19:44.040 loom larger than gains about two to one. And you 0:19:44.080 --> 0:19:49.160 know an example how to bring that out is I'll 0:19:49.200 --> 0:19:51.280 offer you a gamble on the toss of a coin. 0:19:51.640 --> 0:19:54.439 You know, if it chose tales, you lose one hundred 0:19:54.720 --> 0:19:59.120 and if it chose heads, you win X. Now what 0:19:59.160 --> 0:20:02.600 would ex have to be for that gamble to become 0:20:02.680 --> 0:20:05.520 really attractive to you? Well, more than a hundred, so 0:20:05.560 --> 0:20:09.159 it's more than Actually you're a professional. There is a 0:20:09.200 --> 0:20:14.000 difference of professionals than others most people, and that's been 0:20:14.040 --> 0:20:17.719 well established. The men more than two hundred really, so 0:20:17.760 --> 0:20:22.000 they want two to one odds, which is it's not 0:20:22.160 --> 0:20:24.480 the odds, I mean the odds I went to one. 0:20:24.880 --> 0:20:28.439 It's equal chance to payout. It's the payout has to 0:20:28.480 --> 0:20:31.840 be to to one, meaning that it takes two hundred 0:20:31.880 --> 0:20:35.840 dollars of potential gain to compensate for one hundred dollars 0:20:35.920 --> 0:20:39.640 of potential loss when the chances of the two are equal. 0:20:40.280 --> 0:20:43.600 So that's loss of version. Terms out that loss of 0:20:43.720 --> 0:20:48.719 version has enormous consequence, enormous absolutely so. So that leads 0:20:49.200 --> 0:20:52.760 to a couple of really interesting questions. The first one 0:20:52.920 --> 0:20:57.800 is what is it about losses that makes them so 0:20:57.920 --> 0:21:01.840 much more painful than gets are pleasurable? In other words, 0:21:02.040 --> 0:21:05.879 why does this two to one risk of loss of version? 0:21:05.880 --> 0:21:09.800 Why does this even exist? Well, I mean you know this, 0:21:09.800 --> 0:21:13.640 this is evolutionary. I mean you you would imagine that 0:21:14.280 --> 0:21:19.000 in evolution, threats are more important than opportunities. That makes 0:21:19.000 --> 0:21:22.040 a lot of sense, And so it's a very general 0:21:22.080 --> 0:21:26.479 phenomenon that sort of bad things. So the preemptal are 0:21:26.600 --> 0:21:30.520 stronger than good things in our experience. So loss of 0:21:30.640 --> 0:21:33.960 version is a special case of something much broader. So 0:21:34.000 --> 0:21:38.119 there's always another opportunity coming along, another game, another deer 0:21:38.160 --> 0:21:42.080 coming by, but an actual genuine loss. Hey, that's permanent. 0:21:42.119 --> 0:21:44.760 You don't recover from that. That's right anyway, you take 0:21:44.800 --> 0:21:48.520 it most seriously. So there is a deer in your 0:21:48.560 --> 0:21:51.560 sights and a lion, you are going to be busy 0:21:51.560 --> 0:21:54.359 about the lion and not about the deer. Makes sense. 0:21:54.840 --> 0:21:57.880 That leads to the obvious question, well, what can investors 0:21:57.960 --> 0:22:02.960 do to protect themselves against this hardwired Uh? Well, loss 0:22:02.960 --> 0:22:06.840 of her Uh there's everything they can do. One is 0:22:07.560 --> 0:22:10.160 not to look at their results, not to look too 0:22:10.160 --> 0:22:13.360 often at how well they're doing. And today you could 0:22:13.400 --> 0:22:16.400 look tick by tick, minute by minute. The worst thing, 0:22:16.480 --> 0:22:19.800 it's a very very bad idea to look too often. 0:22:19.960 --> 0:22:23.800 When you look very often, you attempted to make changes. 0:22:24.440 --> 0:22:28.920 And where individual investors lose money is when they make 0:22:29.040 --> 0:22:35.160 changes in their allocation virtually on average. Whenever an investor 0:22:35.240 --> 0:22:39.159 makes a move, it's likely to lose money because they 0:22:39.200 --> 0:22:43.200 are professionals on the other side, betting against the kind 0:22:43.240 --> 0:22:48.080 of moves that individual investors. I'm Barry Hults. You're listening 0:22:48.119 --> 0:22:51.560 to Masters in Business on Bloomberg Radio. My special guest 0:22:51.600 --> 0:22:55.240 today is Danny Kahneman. He is the Nobel Prize winning 0:22:55.280 --> 0:23:00.600 psychologist formerly professor at Princeton who has had an enormous 0:23:00.600 --> 0:23:05.280 influence on the fields of economics and investing. Let's get 0:23:05.359 --> 0:23:09.240 right back to the question of investing and the professionals 0:23:09.400 --> 0:23:12.679 versus the amateurs. Do we see the same sort of 0:23:13.119 --> 0:23:17.800 biases and errors amongst the professionals. They're clearly much attenuated 0:23:17.840 --> 0:23:20.720 among professionals. So I'll give you an example. I mean, 0:23:20.760 --> 0:23:23.680 and that's the biggest example. It's what makes lots of 0:23:23.800 --> 0:23:28.080 version important. If I ask you, would you take a 0:23:28.119 --> 0:23:31.359 gamble if I ask a regular person in the street, 0:23:31.480 --> 0:23:34.240 Not you, because you're a professional, But if I ask 0:23:34.280 --> 0:23:36.800 a regular person in the street, would you take a 0:23:36.800 --> 0:23:39.919 gamble that if you lose, you lose a hundred dollars. 0:23:39.920 --> 0:23:42.440 If you win, you win a hundred and eighty on 0:23:42.760 --> 0:23:45.440 the toss of a coin. That's a no brainer. Well, 0:23:45.480 --> 0:23:49.280 it's a no brainer for professionals. Most people don't like it. 0:23:49.680 --> 0:23:56.159 Really do that all day long? Yeah, because you're a professional. Now, 0:23:56.520 --> 0:23:59.800 when you ask the same people in the street, Okay, 0:24:00.080 --> 0:24:03.760 don't want this one? Would you take ten? So we'll 0:24:03.800 --> 0:24:07.560 toss tin coins and every time, if you lose, you 0:24:07.640 --> 0:24:10.080 lose a hundred, and if you win, you win a 0:24:10.200 --> 0:24:16.159 hundred and eighty. Everybody wants the tin. Nobody wants the one. So, 0:24:16.200 --> 0:24:23.080 in other words, they think the mathistatistics in repeated play. 0:24:23.160 --> 0:24:27.679 When the game is repeated, then people see they become 0:24:27.800 --> 0:24:31.800 much closer to risk neutral and they see the advantage 0:24:31.800 --> 0:24:37.600 of gambling. Now professionals are in a repeated play situation. 0:24:38.000 --> 0:24:42.240 That's the biggest difference, And so they view each decision 0:24:42.320 --> 0:24:45.040 that they make out of a stream of decision that 0:24:45.119 --> 0:24:48.480 they're going to make. Now, this, by the way, is 0:24:48.520 --> 0:24:52.439 true for investors as well. One question that I asked 0:24:52.520 --> 0:24:55.520 people when I tell them about that, So you've turned 0:24:55.560 --> 0:25:00.960 down a hundred hundred and eighty now, but you would 0:25:01.000 --> 0:25:04.119 accept ten of those? Now, are you on your deathbed? 0:25:04.440 --> 0:25:07.280 That's the question I ask if that the last decision 0:25:07.359 --> 0:25:10.159 you're going to make, And clearly they are going to 0:25:10.240 --> 0:25:15.080 be more opportunities to gamble, perhaps not exactly the same gamble, 0:25:15.320 --> 0:25:18.240 but there will be many more opportunities. You need to 0:25:18.280 --> 0:25:21.880 have a policy for how you deal with risks and 0:25:21.920 --> 0:25:26.679 then make your decisions, your individual decisions, in terms of 0:25:26.720 --> 0:25:31.200 a broader policy. Then you will be much closer to rationality. 0:25:31.480 --> 0:25:34.200 But on the single flip of a coin, the average 0:25:34.240 --> 0:25:36.600 individual is going to look at this and say, hey, 0:25:36.640 --> 0:25:39.080 I'll feel foolish if I lose a hundred, even though 0:25:39.119 --> 0:25:42.560 the payout is greater than my potential law that's exactly 0:25:43.080 --> 0:25:46.560 what happens, and you shouldn't feel that way. I mean, now, 0:25:46.600 --> 0:25:49.280 it's true that you will feel like a fool. It's 0:25:49.440 --> 0:25:52.240 very closely related to what you see as all. There 0:25:52.400 --> 0:25:56.240 is that as we tend to see decisions in isolation, 0:25:57.440 --> 0:26:01.040 we don't see a decision about whether I take this 0:26:01.200 --> 0:26:05.400 gamble as one of many similar decisions that I'm going 0:26:05.440 --> 0:26:09.280 to make in future. So are people overly outcome focused 0:26:09.359 --> 0:26:13.400 to the detriment of process? What they are We call 0:26:13.560 --> 0:26:18.760 that narrow framing. They viewed the situation narrowly, and that 0:26:19.000 --> 0:26:22.800 is true in all domains. So, for example, we said 0:26:22.840 --> 0:26:25.879 that people on my opic that they have a narrow 0:26:26.160 --> 0:26:29.920