Human reasoning is riddled with mistakes, false assumptions and misinterpretations, so if investors want to make better financial decisions they need to know how these biases impact on their thinking and how to counter them.
That’s the barebones message from psychologist Daniel Kahneman who has spent his entire career examining how the mind makes decisions culminating in winning the Nobel Prize for economics in 2002.
Kahneman takes the view that economists try to explain the inexplicable by making excuses or placing undue weight on events that are random – and maintains success is really all down to luck.
Take the current plight of the Pound.
Investors can make decisions about how to manage their cash but can only account for the factors that they control – such as how much money to stake, when to place and pull the money from the markets and so on.
Factoring in the unknown
They cannot factor in the unknown, like British Prime Minister suddenly deciding to let MPs debate her Brexit plans. This decision bounced the value of the Pound up a little against a basket of 31 world currencies.
Investment is making decisions that may not come to fruition for decades based on a scarcity of relevant information.
Two decades ago, the pensions landscape was very different, with companies offering generous final salary benefits that were for the most part fully funded.
Today, those same companies are rushing to close scheme and pay-off retirement savers with golden goodbyes as they struggle to shovel cash into black holes worth almost a collective £1 trillion for FTSE listed companies.
No one can predict the future
That’s why investors can only make the best decision they can based on the information available at the time and need to regularly review how their money is performing.
The considered opinion must be any investment is a shot in the dark because no one can predict the future.
Complicated graphs and wealth manager speak is a way to look in the know when they really do not have much more of a clue than anyone else about how the markets are likely to shift.
Kahneman’s writings are a true eye opener. He rubbishes experts and proves time and again with simple experiments that their insights are flawed.