Tuesday, January 20th, 2015
confidence game

Seth Klarman once said, “You need to balance arrogance and humility . . . when you buy anything, it's an arrogant act.”  However, “you need the humility to say ‘but I might be wrong.’  And you have to do that on everything.”Santangel’s Review | The quotes come from an interview with Charlie Rose.

Or, as Barbara Kruger’s installation at the Hirshhorn Museum in Washington, D.C. yells out in bold letters:  “BELIEF + DOUBT = SANITY.”Hirshhorn Museum | Here is the Hirshhorn’s information about it.

It’s important to note that without a certain amount of confidence, we wouldn’t get very far.  As individuals that’s 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 “overconfidence.”  And then we make poor decisions.

Daniel Kahneman’s Thinking, Fast and Slow delved into that “puzzling 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.”  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 don’t let that stop us.  “The 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,” Kahneman wrote.  Your feeling about something — your confidence in it — “is determined by the coherence of the best story that you can tell from the evidence at hand.”

Because even “poor evidence can make a very good story,” we persist in making forecasts even when we shouldn’t.  To complicate matters, “optimism is highly valued, socially and in the market; people and firms reward the providers of dangerously misleading information more than they reward truth tellers.”

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 don’t know, will they listen to our story?

Most definitions of “confidence game” reference a swindler defrauding a victim after the the victim’s 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.the research puzzle | Not knowing in advance who falls into what category, in all cases our goal should be to “crack the narrative.”

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 — and, here’s the kicker — 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, Kahneman’s research partner Amos Tversky told a group of investment professionals, “Time 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.”CFA Institute | The quote comes from the Q&A session at a 1995 conference put on by CFA Institute (when it was called AIMR).

Have we taken those lessons to heart?  For the most part, no.

We continue to play the confidence game.  We haven’t 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) aren’t just fodder for popular books, but actually change how decisions are made.