A Noble Prize winner had some sobering comments today for hundreds of financial professionals at the IMCA 2015 New York Consultants conference in Manhattan.
You and your clients know less about investing than you think. Keep brilliant investing ideas to a minimum. Don’t overtrade. Passive management is often best. Most investment forecasts miss the mark. Hindsight will often fool both investors and advisors. That’s caused by putting the past in an optimistic light, forgetting mistakes and playing up seemingly correct calls. And luck, not enlightened management, can be often a huge factor in strong investment returns as well as Super Bowl victories.
Those were some of the comments of Daniel Kahneman, the father of behavioral economics and the winner of the 2002 Nobel Prize in economics.
“People are prone to hindsight,” he told the advisors, warning that they can fool themselves by thinking that the future is easy to forecast even when they repeatedly are wrong.
“What this hindsight is, is that an event that looked very uncertain before it happened then seemed very obvious after the fact, when we know it occurred,” according to Kahneman.
“What I’m telling you is that the world is not predictable. And what that means, from my point of view, it is that a lot of what happens is luck,” Kahneman said. “Things happen that we have no control over.” People, in hindsight when things go right, tend to overestimate their abilities and underestimate luck. “And that’s true in everything,” he said.
The hindsight danger, he added, isn’t just one bad call. It is the tendency of advisors and their clients to believe that the “future is knowable.” It is the danger that somebody “ought to know” what the future is, according to Kahneman. He added that financial professionals need to consider this potential for error because it can profoundly affect client relationships.
“The hindsight phenomena has terrible implications for decision making and they also have quite terrible implications for the relationships between clients and financial advisors,” he noted
Kahneman, a Princeton University emeritus professor of psychology, is the author of the book, “Thinking Fast and Slow.” He used a sports analogy to illustrate the dangers of advisors and sports analysts employing the hindsight syndrome. His example was the recent Super Bowl triumph of the New England Patriots over the Seattle Seahawks.
“Notice the credit the Patriots got because the Seahawks made an absolutely stupid call,” Kahneman noted. (A botched last minute play by Seattle handed the game to New England, which was on the verge of losing the game).