A trader works in the S&P 500 pit on the floor of the CME Group’s Chicago Board of Trade.
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Nobel Prize-winning psychologist and economist Daniel Kahneman has a new book out asking a question that is central to making the right calls on the markets and money: Why does everyone make such bad decisions and what can we do about it?
“Noise” was co-written with Olivier Sibony, a French expert in decision making, and Cass R. Sunstein, a legal scholar and behavioral economics expert. Kahneman is one of the founding fathers of behavioral science and author of the seminal work, “Thinking Fast and Slow.”
My review of the book is here:
I sat down with Dr. Brad Klontz, a member of the CNBC Financial Wellness Council to get his reaction to Kahneman’s central thesis, which is that biases and noise (random variability in our judgments) are ever-present in our lives, but there are ways we can improve our judgment skills. Dr. Klontz is a CFP and psychologist and author of several books, including most recently, “Money Mammoth” (Wiley, 2020).
CNBC: The central thesis of the book is that people — particularly professionals like doctors, judges, and financial advisors — often make very bad judgments. Radiologists don’t provide consistent interpretations of X-rays. Judges don’t provide consistent judgments. Financial advisors are overconfident in their advice. Do you concur?
Klontz: Yes. Being an expert in a particular field can make biases more difficult to identify, more resistant to change, and lead to greater harm.
CNBC: Kahneman says there are problems with “bias,” where people are consistently weighted toward one viewpoint, like a bathroom scale that is always two pounds over. But his emphasis is on “noise” which he calls “random variability in judgments,” where the decision-making is random and inconsistent. Why does that happen?
Klontz: Partly it’s a problem that people don’t recognize the random nature of their decision making. But there’s other reasons. While it can backfire, ironically, variability in judgment has been one of the keys to our survival as a species. Many decisions are not black and white. In primitive times and today, people could die from a bad judgment, so there is a bit of natural selection in there.
This problem is well-known in the field of psychology. For example, random error exists in all attempts to measure things, such as personality traits or the effectiveness of medications or therapies. We use the scientific method and statistical analysis to try to mitigate random error, but it is always a threat to our trying to make sense of objective truth.
CNBC: Kahneman recommends several ways to combat bad decision making and noise. He talks about “decision hygiene” or ways of making more consistent judgments. Does that make sense?
Klontz: Yes. I love the concept of delaying intuition,…
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