When Delusion Trumps Logic
And why that means I’m having paella tonight.
Here’s something I’m told Nobel Prize winner Daniel Kahneman said recently at a conference:
Algorithms are now as smart as humans 50% of the time, which means they will win because they are much less expensive. And the other 50% of the time, they are smarter than humans.
So…
So, Kahneman is right. And what’s astounding about that is how little we have handed over to algorithms given that fact.
Take me, for example
Here’s generally how my Saturday morning unfolds. My kids wake me up too early; I stumble downstairs to make coffee and breakfast; as the kids eat breakfast I ask them what they want to eat for lunch that week, check online what’s on sale at the grocery store, and peruse a bunch of cookbooks, magazines, and websites to decide what’s going to be on the menu that week. When I’m done, I make a shopping list. Then we go shopping (unless Arsenal is on, in which case we watch the game before we go shopping).
Why am I doing this? An algorithm that systematically cross-referenced my budget with what’s on sale at the store with the food my family likes with how much time I have to cook with some optimal dietary guidelines and so on would do better, act faster, and yield more efficiency. It’s a fact, for example, that consumers throw away 15% to 25% of the food we purchase. Think about the costs associated with that. Not only for consumers who are buying more than they need, but also the costs of production to the world.
Two things keep me from changing my Saturday routine in light of that awareness:
- While an algorithm might be right for others, I continue to believe that my discretion adds value.
- I enjoy it.
See, it’s fun to try to be creative. I have a bias to trying new things. I enjoy reading recipes. I get a dopamine hit when I make an impulse purchase at the store.
The need to be human is what prevents us from being logical.
Logic in your financial life
This is also true in the financial industry, which is a space where automation, math, and algorithms allegedly run wild. And while it’s true that there has been a massive push into index-based investing, that more asset allocation plans are dictated by computer math, that computer-driven high frequency trading amounts for most of the stock market liquidity today, and that algorithmic trading plans such as VWAP (volume-weighted average price) and POV (percent of volume) orders account for most trading directives today, the fact is that humans continue to desire human input and make loads of bad decisions on things they should just hand over to machines.
For example, here’s what a recent survey by asset manager Natixis discovered:
When asked how they fared in 2015, individuals told us on average that they generated a 5.8% return in 2015 — this despite high volatility and significant market losses worldwide. While these levels may be plausible in Europe, the average U.S. moderate risk portfolio analyzed by our Portfolio Clarity service returned -0.92% compared to a return of 1.38% for the S&P 500 Index in 2015. Even in cases where investor estimates are accurate, expectations were not met and only 18% of respondents worldwide claim they were satisfied with their results.
Put simply, while (1) most investors lost to the market they (2) thought they beat it but (3) were still dissatisfied.
This is a dumpster fire of delusion.
The damage of delusion
It’s no wonder the financial industry continues to largely overpromise, underdeliver, and charge too much. When there are no accepted facts, the opportunity for deception is rich.
The same set of survey respondents, for example, said that they require 9.5%(!) real returns but prioritize safety over performance and don’t actually have any financial goals that might level set those expectations. This is an impossible scenario, but someone out there will be willing to promise it if someone else out there wants it.
It’s for this reason that I chuckled when I saw that most investors still want financial advice from a human but that the top three reasons for cutting bait with a financial professional were dissatisfaction with performance, a failing to understand financial goals, and differing investment views.
Good Lord.
If you’re seeking safe 9.5% real returns then you are condemning yourself to a life of dissatisfaction, misunderstanding, and differing views. This reminds me of a conversation I once overheard between and investor and his money manager.
Money manager: So when the market’s up, you want me to be up more?
Investor: Yes.
Money manager: And when the market’s down you want me to be up?
Investor: Yes.
Money manager: And you want to be up every year?
Investor: Uh-huh.
Money: And you want me to charge less than one percent.
Investor: Yeah.
Money manager: Well, God don’t work for one percent.
So where does that leave us? With algorithms. Refreshingly logical algorithms. Sure, they don’t care for your views, but if your views are that you require 9.5% real returns, then you are not qualified to have views in the first place.
So think about the verticals in your life where more logic would be accretive. How might you turn them over to machines? If Danny Kahneman is right, you’ll do better, save money, or both.
That’s what I’ll be doing — right after I get my paella on the stove.
