Speaker 1: Everybody wants to be a great investor. We love the
Speaker 1: idea of outperforming the markets, or at the very least,
Speaker 1: beating our peers. The problem with all this foolishness is
Speaker 1: that nearly all of us lack the skill set and
Speaker 1: discipline required to create those better than average returns. Worse yet,
Speaker 1: we often fool ourselves into believing we are much more
Speaker 1: skilled than we actually are.
Speaker 2: We don't get a game.
Speaker 1: I'm Barry Ridhelts, and on today's edition of At the Money,
Speaker 1: we're going to discuss metacognition, our ability to self evaluate
Speaker 1: our own skills. To help us unpack all of this
Speaker 1: and what it means for your portfolio, let's bring in
Speaker 1: Professor David Dunning of the University of Michigan. He is
Speaker 1: the author of several books on the psychology of self
Speaker 1: and best known for his research known as the Dunning
Speaker 1: Kruger Effect. So welcome, Professor Dunning. Let's start with the basics.
Speaker 1: What is the Dunning Kruger effect.
Speaker 2: The Dunning Kruger effect is the basic idea that people
Speaker 2: who lack expertise lack the very expertise they need. To
Speaker 2: recognize the fact that they lack expertise, that is, if
Speaker 2: you don't know, you don't know what you don't know.
Speaker 2: And so the basic problem people have is they fail
Speaker 2: to recognize their own ignorance when it comes to their
Speaker 2: skill or if it comes to any particular decision that
Speaker 2: they may have in front of them that day.
Speaker 1: So it sounds like metacognition is a separate skill from
Speaker 1: whatever fields we may be working in it. It could
Speaker 1: be business, it could be financed, it could be sports.
Speaker 1: The ability to self evaluate is its own ability.
Speaker 2: Well, it certainly is its own task that we have
Speaker 2: to come to a decision or at least some sort
Speaker 2: of judgment, and then there's a second task of should
Speaker 2: we be confident in that decision or should we have doubt?
Speaker 2: And that's that second task, and often that's the important
Speaker 2: one that determines whether or not we're going to act,
Speaker 2: or whether we're going to seek advice or hedge or
Speaker 2: seek insurance. And it does have some skills associated with it,
Speaker 2: but often doing the second task well requires the same knowledge,
Speaker 2: the same expertise as doing the first task well. And
Speaker 2: that's where the dudding Kruger effect comes in. That's the paradox,
Speaker 2: the conundrum, the issue, But it is a second task
Speaker 2: that is very very important.
Speaker 1: So if we are not expert in a given space,
Speaker 1: it sounds like that implies we also lack the ability
Speaker 1: to judge our own lack of expertise.
Speaker 2: That's right. We have a as we call it, a
Speaker 2: double burden. We lack the skills to make the correct
Speaker 2: decision in the first place. That also means we don't
Speaker 2: necessarily have the skills to be able to evaluate the
Speaker 2: decisions that we've made.
Speaker 1: So this seems to be a very common problem in
Speaker 1: the field of investing. With newbies or people who are
Speaker 1: early in their investment career, they have a little bit
Speaker 1: of success, sometimes it's luck, maybe there's some skill involved
Speaker 1: or some combination of both, but they develop a bit
Speaker 1: of overconfidence and that allows them to forget about, Hey,
Speaker 1: maybe I'm not an expert. How dangerous is this out
Speaker 1: there in the world.
Speaker 2: Well, it can be dangerous. One thing to point out
Speaker 2: is that it's a danger for everybody, no matter what
Speaker 2: your level of expertise is. As soon as you step
Speaker 2: into your own pocket of incompetence, well you're vulnerable to
Speaker 2: this effect. But if you're new to something, and you're
Speaker 2: very vulnerable to this effect. If you're learning something if
Speaker 2: you have a little experience. While your experience is valuable,
Speaker 2: but you may overplay its value. You may overlearn what
Speaker 2: you've learned from just a little bit of experience with something.
Speaker 2: And I think you know things that actually turned out
Speaker 2: to be luck or misteries the situation, and that could
Speaker 2: leads you to fall prey to the Dunning Kruger effect.
Speaker 1: So this sounds a little bit like overconfidence. How does
Speaker 1: Dunning Kruger effect differ from just straight up having too
Speaker 1: much belief in your own abilities?
Speaker 2: Well, overconfidence is a general phenomenon and you can find
Speaker 2: it everywhere. I would actually argue that overconfidence is inevitable.
Speaker 2: In some sense, it's something that we're all going to experience,
Speaker 2: and in a sense it's something that we all have
Speaker 2: to manage. It's just an inevitable fact of life. What
Speaker 2: the Dunn Kruger effect is is just one particular ingredient,
Speaker 2: one spice that can lead people into overconfidence. That is,
Speaker 2: when you are not an expert, when you're in a
Speaker 2: situation that's new to you. This is exactly when you're
Speaker 2: in a situation where you may become quite overconfident. You
Speaker 2: may think that you've got this, when in fact you're
Speaker 2: nowhere near having this if you will. It's one of
Speaker 2: the situations where overconfidence maybe it's most pointed or it's
Speaker 2: most severe.
Speaker 1: So how should we think about our own blind spots?
Speaker 1: What can we do to make ourselves more self aware
Speaker 1: of the areas that we need some improvement in.
Speaker 2: One of the things I keep thinking about is to
Speaker 2: resurrect that old Apple slogan, Apple computer slogan of thing different,
Speaker 2: to ask other people what they think and see if
Speaker 2: they think something different, or do what the professions, being
Speaker 2: a lawyer or being a doctor do. If you look
Speaker 2: at the professions, they actually institutionalize thinking different. In the
Speaker 2: American legal system, if you're a lawyer, you present your
Speaker 2: case and there will be another law who is going
Speaker 2: to think different from you. In fact, that lawyer is
Speaker 2: going to think the opposite of you, and it's going
Speaker 2: to poke holes in every single argument you make. They
Speaker 2: will be thinking different. The idea in the legal systems,
Speaker 2: the truth will come out of that competition between your
Speaker 2: side and the other side. Doctors don't make diagnoses. They
Speaker 2: do differential diagnoses. They don't consider what your problem medical
Speaker 2: problem might be. They consider multiple medical problems and trying
Speaker 2: to figure out what rules in this medical problem, what
Speaker 2: rules out these other medical problems.
Speaker 1: So poor performers generally overestimate their skill at performance because
Speaker 1: their incompetence deprives them of the skills they need to
Speaker 1: recognize that deficit. What else should we be doing to
Speaker 1: avoiding those sort of problems you talked about speaking to
Speaker 1: other people, we talk about thinking differently. What other options
Speaker 1: do we have in our toolkit to avoid these mistakes?
Speaker 2: Always be learning? That is the easiest way to avoid
Speaker 2: the problems of incompetence is to become competent. Although that's
Speaker 2: very easy conceptually. I know it's hard to do in reality,
Speaker 2: but you can always become more competent if you will.
Speaker 2: It can always be learning. One of the things I
Speaker 2: tell my graduate students the way you want to feel
Speaker 2: is if you take a look at something you've done
Speaker 2: in the past, like some sort of research study you've
Speaker 2: created or something you've written, is that you should always
Speaker 2: feel vaguely embarrassed by it, that there are things you
Speaker 2: wish you'd done differently. And if you feel that way,
Speaker 2: that that's a very good feeling because that means you've grown.
Speaker 2: If you're perfectly satisfied with it. I would be scared.
Speaker 2: That means you haven't grown. And I myself am delighted
Speaker 2: to say I continue to embarrass myself constantly all the time.
Speaker 2: When I read myself, even in the recent past, I'm
Speaker 2: delighted that I'm still an embarrassment. I wish it would end,
Speaker 2: But then again, I wish it wouldn't end.
Speaker 1: Huh. Quite fascinating. So to wrap up our inability to
Speaker 1: evaluate our own skill sets, especially when we're first starting
Speaker 1: out as investors, is a very troubling and potentially expensive
Speaker 1: human trait. However, if we find ourselves mentors, if we're
Speaker 1: always learning, if we look back at what we used
Speaker 1: to do and recognize, hey, that's a little embarrassing, it
Speaker 1: means that we've come a long way. As long as
Speaker 1: we can objectively measure our performance, take steps to get better,
Speaker 1: and try and stay within our own abilities, we can
Speaker 1: have much better outcomes. I'm Barry Rudults. This is Bloomberg's
Speaker 1: at the Money.
Speaker 2: We don't get proved again. A