Source: Smart Investor Author: Ina

In the morning, amidst the sound of heavy rain in Shanghai, a message flashed through the investment group:

On March 27, local time, Daniel Kahneman (Daniel Kahneman), an Israeli-American cognitive psychologist, Nobel laureate in economics, and author of “Thinking Fast and Slow” and “Noise,” passed away at the age of 90.

Known as the “father of behavioral economics,” Kahneman is a professor of psychology and public affairs at Princeton University in the US. He holds the titles of professor at Hebrew University in Israel, the University of British Columbia in Canada, and the University of California at Berkeley. He is considered the greatest psychologist of our time, after Freud.

Obama has publicly stated that he is a loyal reader of Kahneman. Amazon founder Jeff Bezos, Google founder Larry Page, Sergey Brin, SpaceX founder Musk, and Twitter founder Evan Williams are all his students.

The reason he has attracted much attention in the investment community is that he applied his comprehensive insight from the field of psychological research to fields such as economics and cognitive science, and even Buffett and Munger have benefited.

Traditional microeconomic analysis is based on the conditions of rational human assumptions (rational of rational man). It is assumed that the subject of economic decisions is full of reason, unemotional, not blindly following, and is good at judgment and calculation.

This is called the Expected Utility Theory (Expected Utility Theory), which depicts rational behavior.

However, Kahneman and Amos Tversky (Amos Tversky) discovered in research in the 70s of the last century that people make decisions under uncertain conditions seem to depend on the gap between results and expectations rather than the results themselves.

In other words, when making decisions, people have a reference standard in mind. Decisions depend more on how big the gap is with the reference standard. For example, the salary increase by 100 yuan doesn't feel like anything, but if it were to be reduced by 100 yuan, then you definitely need to ask clearly.

To explain these phenomena, Kahneman and psychology genius Tvorsky proposed the “Prospect Theory” (Prospect Theory) in 1979, which complements expected utility theory to describe actual behavior.

Obviously, this theory has been widely discussed in today's financial markets. No book on behavioral economics can get around this theory. Kahneman's Google Scholar page shows that his work has been cited more than half a million times!

We can use specific examples to summarize the basic principles of outlook theory:

• Deterministic effect: Between determining returns and “taking a gamble,” most people choose the former. As is said, two birds in the forest are not as good as having one in hand;

• Reflex effect: Between determining losses and “taking a gamble,” most people choose the latter. After all, the latter can still struggle;

• Loss aversion: even if you pick up another 100 yuan, it's hard to offset the pain of losing 100 yuan;

• Obsession with a small probability: buying a lottery ticket;

• See dependency: Among the options “someone else earns 60,000 and you earn 70,000” and “someone else earns 90,000 a year and you earn 80,000”, most people will choose the former.

Simply put, when faced with profit, people are unwilling to take risks; when faced with losses, they are also willing to take risks, and people are more sensitive to losses than gains. Therefore, under different risk expectations, people's investment behavior tendencies can also be predicted.

Kahneman also won the 2002 Nobel Prize in Economics for his research contributions on the thesis “how humans make judgments and decisions under uncertain conditions.”

This Nobel Prize is unique in that he is the first psychologist in history to win the Nobel Prize in Economics for his psychological research. Of course, this honor also belongs to Tewoski, who died in 1996.

What made Kahneman's ideas more profoundly influenced the cognitive science community are two of his well-known works. One is “Thinking, Fast and Slow” (Thinking, Fast and Slow), which he published in 2011, and is treasured by the investment community.

In his book, he said that the brain has two ways of making decisions: fast and slow:

(Think fast) The commonly used unconscious “System 1” relies on emotion, memory, and experience to make quick judgments.

However, it adheres to the principle of “sight is truth”, and it is easy to be fooled and allow illusions such as loss aversion and optimism to guide humans to make wrong choices. For example, determining how far and close two objects are, and detecting unfriendliness in each other's tone...

(Slow Thinking) A conscious “System 2” that analyzes, solves problems, and makes decisions by mobilizing attention.

It's slower and less prone to errors, but it's lazy and often takes shortcuts. For example, comparing the efficiency of the two refrigerators, drawing up an important contract...

Kahneman once met the chief investment officer of a major company and invested heavily in Ford Motor's stock just because he was attracted to a Ford model at an auto show.

As a pioneer in the field of decision making and judgment research, Kahneman discusses his own and others' mistakes in judgment and decision-making in rich and accurate language in his book. “The Black Swan” author Nassim Nicholas Taleb once praised “Thinking, Fast and Slow”:

It is a landmark work of social thought, comparable to Adam Smith's “The Wealth of Nations” and Sigmund Freud's “The Analysis of Dreams.”

After 10 years of preparation, Kahneman also published a book, which has been frequently mentioned in the past two years, namely “Noise: Flaws in Human Judgment” published in 2021.

Over the years, people have been more inclined to bias as the key to making mistakes in human judgment, but Kahneman pointed out that noise is the black hole that affects human judgment.

Summarized in one sentence: human error of judgment = deviation+noise.

“The noise is like a leaky basement. The reason it's tolerated is not because people think it's acceptable, but because it hasn't been noticed.” Kahneman wrote in the book. The noise spread across all fields such as investment, management, law, education, etc. It was random, yet fatal.

If we can fully recognize the noise, we may be able to avoid investment pitfalls we haven't noticed.

If “Thinking, Fast and Slow” is about defeating the enemy “bias” in human judgment, then what “Noise” wants to kill is another of these invisible enemies — noise.

Robert Theodini, the author of “Influence,” who was liked by Munger to send Berkshire shares, also said:

The impact of “Noise” is shocking because it explores a fundamental and grossly underestimated danger in human judgment.

Smart investors have heard countless times about being profoundly influenced by Kahneman's books during interviews, road shows, book meetings, and many other exchanges with investors.

@莫泰山 (Chairman of the Hakudo Foundation):

Long-term investment requires not only slow thinking, but also slowing down to witness greatness and wait for compound interest. Long-term investments are indeed a bit difficult to sustain; easy to know and hard to do. How do I do that? Extend your investment period a little longer. You don't have to race against time to invest. You set a period of 3-5 years for your spare money. If you can have 10 years, it's better, so your mentality will be a little calmer.

In addition, long-term investments also involve quick thinking. As mentioned in “Thinking, Fast and Slow,” when faced with an uncertain situation, 36 measures are taken as the best strategy, run quickly, and avoid risks. This is also a very useful human instinct.

When it comes to investing, we have time to think slowly. Some slow thinking, probabilistic thinking, reverse thinking, and long-term thinking help us invest better and help us slowly become rich. For good companies, as long as we have enough patience, we are likely to wait for better results.

@姜诚 (General Manager and Investment Director of the Sino-Thai Asset Management Fund Business Department):

As far as the economy is concerned in the short term, both macroeconomics and micro individuals, there will be cyclical fluctuations, and the same goes for the stock market. It's just that during the cyclical downturn, everyone is constantly constructing narrative errors themselves. Just like the cognitive bias proposed by Kahneman, when something bad happens, you must find a causal relationship, you must construct a reason, and then think that this reason will persist for a long time, so it will never be good. This forms a linear extrapolation.

(Recommended reading “Noise”) What is noise? What is deviation? What are the categories of noise? How to recognize and overcome noise? Master Kahneman is always systematic and profound.

@周良 (Founder of Minority Investment):

We have a few must-read books, such as “Thinking, Fast and Slow,” and another book called “Handbook of Behavioral Investing.”

The book “Thinking, Fast and Slow” is a classic book in the field of behavioral economics. It explains that people have two ways of thinking, one called quick thinking, and the other called slow thinking. In our daily lives, most people use quick thinking; it is intuitive and emotional.

Slow thinking takes a lot of mental effort and takes a long time, but the biggest characteristic is that it is accurate, takes a long time, and can be verified. You can't make a mistake in judging it. It's also something we often say, that will see people's hearts over time.

Therefore, fast thinking is efficient and easy to make mistakes. Slow thinking is very inefficient, but the accuracy rate is very high. However, human brain capacity is limited, and mental strength is also limited, so the vast majority of people use quick thinking in their daily lives.

We just need to use more accurate slow thinking to find where most people make mistakes in quick thinking. This is our investment method. So it's very unique and very minority.

@舒泰峰 (Chongyang Investment Partner):

Good works can often be condensed into a sentence and directly hit people's hearts. “Wherever there is judgment, there is noise” falls into this category. It's from Kahneman's “Noise.”

In “Thinking, Fast, and Slow,” we know that cognitive biases cause huge damage to judgment, while “Noise” reveals another kind of damage. For example, in (some) sentencing cases, it clearly caused the unfair phenomenon of “not being punished for the same crime.”

In terms of investment, if analysts at the same investment company value a certain stock according to the same standards, one result is 30 yuan, the other is 60 yuan, and even another result is 90 yuan, then who should the investment manager listen to?

You'll definitely think of measuring it using an average value; indeed, this is a good method. However, to eliminate noise according to the averaging method, you must first ensure that everyone's judgment is independent; otherwise, such averaging is meaningless.

“Independence” is an important part of the “decision-making hygiene” strategy proposed by Kahneman. Others include: abandoning individualized expression to pursue accuracy; using statistical thinking to examine cases from an external perspective (putting cases into a series of similar cases); structuring judgments and breaking them down into several independent tasks, which can reduce excessive consistency issues...

Of course, as Kahneman said, it's not that noise needs to be eliminated in any field. For example, in the field of art, keeping some noise would make the world more vivid.

@姚志鹏 (Deputy General Manager of Harvest Fund):

The development of emerging industries often moves forward in the midst of fluctuations, and every time the market fluctuates, there are always pessimistic reasons and various versions of “ghost stories,” but some of the influencing factors are long-term, and some are short-term. In a complex and cluttered world, reduce excessive access to information, move on the path that few people follow, and invest in those high-quality growth targets that are truly few.

This psychologist, born in Israel in 1934, grew up in Paris. He obtained a degree in psychology from the Hebrew University of Israel at age 20 and a doctorate in psychology from the University of California, Berkeley at age 27.

Fortunately, he received the best education in his studies as a child, studied what he was most interested in in middle age with his best partner, and eventually achieved extraordinary results.

What few people know, however, is that this survivor of the Nazi Holocaust went through countless dark nights throughout his life: losing his father at an early age, getting divorced in middle age, seriously ill children... and all he spent his whole life studying was how to make more rational decisions.

We have excerpted the golden quotes from this master psychologist's classic “Think, Fast and Slow,” which have moved so many people. We would like to commemorate Daniel Kahneman, one of the greatest thinkers of our time.

1. Think fast and think slowly

1. The operation of System 1 is unconscious and fast, with little effort, no feeling, and completely under autonomous control. System 2 shifts attention to brain activities that require mental effort, such as complex computation.

2. Some critical tasks can only be performed by System 2, because these tasks require effort and self-control, which can suppress the intuition and impulses generated by System 1.

3. System 2 always takes a long time and is very inefficient when making daily choices in place of system 1. The best solution is compromise: learn to differentiate between situations where major mistakes are common, and try to avoid them when the risk is high.

4. Mood can obviously affect the operation of System 1: when we are uncomfortable and unhappy, we lose our intuition.

5. Our brain will ignore the obvious things and the fact that we have blocked these things.

6. In economic behavior, effort is a cost, and learning skills is to pursue a balance between benefits and costs. Because laziness is human nature.

7. Moving from one task to another requires effort, especially when time is tight.

8. The experiential self answers the question “does it hurt right now?” while the memory self answers the question “how is it overall?” We can only preserve life experiences through memory, so when we think about life, the only perspective we can adopt comes from remembering ourselves.

II. Confidence and Prejudice

9. If you have to force yourself to do something, and at this point you are facing a new challenge, you will be very reluctant or unable to control yourself at all. This phenomenon is called ego depletion (ego depletion).

10. Many people are too confident and trust their instincts too much. They clearly feel that cognitive efforts are meaningless, and they try to avoid free thinking.

11. Understanding the facts is not important; the important thing is that when we need this fact, we are always unable to extract it right away.

12. Cleverness refers not only to the ability to reason, but also to search for relevant information in memory and to mobilize attention when necessary.

13. If you care about whether you are trustworthy and smart in the eyes of others, then be brief and clear when speaking, and don't use complicated sentences when you can use simple sentences.

14. If you agree with a president's political opinions, you may also love his voice and dress. The tendency to love (or hate) someone to love (or hate) everything about that person — including aspects you haven't observed yet — is called the halo effect.

15. The combination of divergent thinking and intensity matching can explain why we can make intuitive judgments about many things we don't know very well.

16. Regarding Bayes' theorem, there are two things we need to keep in mind. You need to know that we always like to make a mess of things. First, the base ratio is very important, even when there is evidence in the case at hand; second, the intuitive impression obtained by analyzing the evidence is usually exaggerated.

17. The normal limitations of the human brain make it incapable of reconstructing past knowledge structures or beliefs. Once you accept a new worldview (or change in how you look at one aspect of the world), you immediately lose a large part of your ability to remember and can't recall the thoughts you had before your perspective changed.

18. A few lucky adventures will cast a dazzling aura on a reckless leader: visionary, brave and courageous.

19. First, prediction errors are inevitable, because the world is unpredictable; second, we should not believe that highly subjective confidence is an indicator of accuracy (low confidence may be more beneficial).

20. Rare events are either overlooked or taken too seriously. Our brain has a useful function; it can't help but focus on strange, different, or unusual things.

III. Choices and Risks

21. When people are tired or exhausted, they are more likely to be influenced by empty yet persuasive information, such as advertisements.

22. Once you're familiar with it, you'll like it; this is an exposure effect.

23. People always evaluate a person's ability by combining strength and trustworthiness. A strong square chin and a confident smile tell us that this person is capable.

24. Simply put, if you follow your instincts, you will often make mistakes by treating random events as regular events. We all love to believe that most things in life aren't random.

25. Exaggerating trust in a small sample is just one of many illusions — compared to the reliability of the information, we pay more attention to the content of the information itself, and the result is that we will make the world around us simpler and more unified than the data can prove.

26. The most important thing about a good story is the consistency of the information, not its completeness.

27. The world in our minds is not an accurate reflection of the real world; our estimation of the frequency of events is also influenced by factors such as the frequency of our exposure to this information and the intensity of personal emotions.

28. Our brain's ability to solve small risks has a basic limit: we either completely ignore risk or pay too much attention to risk, and there is no middle ground.

29. The probability of people making more detailed and richer descriptions is higher; this is against logic. Prophets always set traps for their clients: detailing the plot makes it more believable, but less likely to become reality.

30. For valuable products, they also give a small cheap gift. In this case, the whole set of products is not that attractive. Less is more is what it means.

31. Learning requires a certain amount of repetition and reinforcement.

32. Optimism bias is probably the most important type of cognitive bias. If you're optimistic, you should be both optimistic and cautious, as optimism bias can be beneficial or risky.

33. (Case) When an agency is about to make an important decision, but no formal resolution has yet been issued, Klein proposes to convene a brief meeting with people who are familiar with the decision.

The conference was preceded by a short speech: imagine we have implemented our current plan today, a year later, but it failed miserably. Please write down the reason for this fiasco in 5 to 10 minutes.

4. Self and Happiness

34. When someone knows that others have heard the same call for help, they feel that the responsibility on their shoulders is reduced.

35. It is very difficult to change one's view of human nature, and it is even harder to change one's view of the dark side of oneself.

36. Rewarding good performance is more effective than punishing mistakes.

37. Success = talent+luck, huge success = more talent+more luck.

38. Remember this rule: don't trust your instincts when the environment lacks firm rules.

39. Poor people can think like merchants, but their motivations are very different. Unlike merchants, poor people care about the difference between acquisition and abandonment.

Their problem is that they can only choose between different losses. Money spent on one item is a loss for another item that could have been purchased. For the poor, spending money means loss.

40. The concept of loss aversion is definitely the most important contribution of psychology to behavioral economics.

41. When people face poor choices, they are desperate. Despite being hopeless, they would rather choose the greater possibility of making things worse in exchange for the hope of avoiding loss. This practice often turns a controllable mistake into a disaster.

42. People are more inclined to avoid losses in a profitable state, and more willing to take risks in a loss-making state.

43. Financial research has recorded the preference of a large number of people to sell their profitable stocks and keep loss-making stocks — this is viewed as a form of prejudice. There is also an obscure and difficult name for this: disposal effect.

44. The sunken cost paradox causes people to waste too much time on things they don't like, such as unhappy marriages and hopeless research projects.

45. Regret is an emotion and a form of self-punishment.

46. When evaluating the whole life and some interesting things, the climax and end are important, and the process is often overlooked.

47. There is a core fact of human existence, that is, time is ultimately a limited resource, yet the human memory self overlooks this fact. People prefer to enjoy short but intense happiness over the long flow of happiness.

48. The easiest way to increase happiness is to allocate your time. Can you take more time out to do the things you love?

edit/lambor