Search results for: Dunning Kruger

Alan Greenspan on the Dunning–Kruger Effect

Did I write The Dunning–Kruger effect?

I mean “Activism.”

You see, Mr. “1%.FOMC.Rates-Nonfeasance-banks.can.self.regulate-its.called.innovation-Greenspan.Put,” had the unmitigated gall, the colossal cojones, the planet sized testicles to blame the current slow recovery on Government Intervention!

Given how utterly unaware the former Fed Chairman is of his own gross incompetentcies, I thought if I used the actual, title no one would believe me.

Alan Greenspan on Activism

Abstract: The US recovery from the 2008 financial and economic crisis has been disappointingly tepid. What is most notable in sifting through the variables that might conceivably account for the lacklustre rebound in GDP growth and the persistence of high unemployment is the unusually low level of corporate illiquid long-term fixed asset investment. As a share of corporate liquid cash flow, it is at its lowest level since 1940. This contrasts starkly with the robust recovery in the markets for liquid corporate securities. What, then, accounts for this exceptionally elevated level of illiquidity aversion? I break down the broad potential  sources, and analyse them with standard regression techniques. I infer that a minimum of half and possibly as much as three-fourths of the effect can be explained by the shock of vastly  greater uncertainties embedded in the competitive, regulatory and financial environments faced by businesses since the collapse of Lehman Brothers, deriving from the surge in government activism. This explanation is buttressed by comparison with similar conundrums experienced during the 1930s. I conclude that the current government activism is hampering what should be a broad-based robust economic recovery, driven in significant part by the positive wealth effect of a buoyant U.S. and global stock market.

Perhaps Messrs Dunning and Kruger would not mind if we renamed their research the Alan Greenspan Effect?


Source: PDF
Greenspan on Activism
Council on Foreign Relations

Transcript: WSJ’s MIB: Paul Vigna on Bitcoin


The transcript from this week’s MIB: Paul Vigna on Blockchain & Cryptocurrency
is below.

You can stream/download the full conversation, including the podcast extras on iTunesBloombergOvercast, and Stitcher. Our earlier podcasts can all be found on iTunesStitcherOvercast, and Bloomberg.



This is Masters in Business with the Barry Ritholtz on Bloomberg Radio.

RITHOLTZ: This weekend on the podcast, I have a special guest, my friend Paul Vigna has been a reporter with the Wall Street Journal for 120 years, he is the author of multiple books on block chain, crypto currency, Bitcoin, this is an area that is quite fascinating and a little bit wonky and if you are at all interested in a crash course, I heartily recommend both of his books or you could spend the next 90 minutes listening to us chat about all sorts of things involving Bitcoin, and to be honest, it’s really me asking Paul questions and him taking me to school about some of the details, history, minutia about Bitcoin.

I am really intrigued at how he breaks the entire block chain/Bitcoin discussion into three distinct groups. The first is the underlying software, the technology of the distributed ledger, a.k.a. block chain, that’s one.

The second is really the fascinating group of cyberpunks and libertarians and just generally kind of wacky dudes and it’s mostly dudes who become enamored of Bitcoin in the early days and helped take it viral from this open source software program to really a full-blown phenomena and now arguably a bubble in the actual coins itself.

And that’s the third part. The Bitcoins, the transactions, the mania surrounding the trading, that’s a different issue than either the people behind it or the technology underlying it. I found the conversation fascinating. I think you will also. With no further ado, my conversation with Paul Vigna.

(UNKNOWN): This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

RITHOLTZ: I’m Barry Ritholtz, you’re listening to Masters in business on Bloomberg Radio. My guest today is Paul Vigna, for the past 20 years, he has been a journalist covering markets and the economy for such august outfits as Dow Jones and the Wall Street Journal. He is the co-author with Michael Casey of two fascinating books on block chain and Bitcoin. His first book was The Age of Crypto Currency, How Bitcoin is Challenging the Global Economy, and his latest book The Truth Machine, Block Chain and the Future of Everything was just released to excellent reviews. Paul Vigna, welcome to Bloomberg.

VIGNA: Barry Ritholtz, how are you?

RITHOLTZ: Very, very well, let’s jump right in to the Bitcoin conversation, you know more about this than just about anybody I know.

VIGNA: That’s a totally untrue statement but…

RITHOLTZ: Well you know.

VIGNA: I know some about it.

RITHOLTZ: Well you don’t know the people I know and apparently everybody else knows less than you so it’s a flawed data set.

VIGNA: It’s all with circles you on it.

RITHOLTZ: That’s right.

But let me ask you this question, what was the initial idea behind the entire concept of Bitcoin?

VIGNA: The initial idea the — so this comes out in October 2008 some guy named Satoshi Nakamoto, nobody knows who he is.

RITHOLTZ: Right, is that a real name, is that is pseudonym?

VIGNA: It’s a pseudonym. Nobody knows what his real name is, who he is, if it’s a team of people, you know, it’s a whole mystery. So this white paper comes out, Satoshi Nakamoto, Bitcoin, I forget the exact title but basically the point is what he is creating is a digital version of cash. So in other words, if you’re a shopkeeper and I come in for a cup of coffee or whatever I hand you a five dollar bill, that is the transaction.

What Nakamoto was trying to do was replicate that transaction digitally on the Internet.

RITHOLTZ: Meaning no paper, no credit card, no banks.

VIGNA: No paper, no credit card, and also an immediate transaction between just you and I that nobody else sees. In other words…

RITHOLTZ: No third party, no government, no banks, no credit card, nobody.

VIGNA: Exactly.

RITHOLTZ: Just buyer and seller.

VIGNA: Right, just buyer and seller, peer to peer electronic money, that was the original idea.

RITHOLTZ: Sounds like a good idea.

VIGNA: Sounds like a good idea, sounds like a simple idea, right?

RITHOLTZ: And remember this is 2008, we are right in the middle of the financial crisis where confidence in banks and governments are at record lows.

VIGNA: Right.

RITHOLTZ: So he comes up publishes this white paper, how do you get from — and where was the white paper published?

VIGNA: He just released it online.

RITHOLTZ: Just on the internet.

VIGNA: Originally it was to this — I think it was an email listserv, you know, one of those distribution lists.



RITHOLTZ: So how do you get from a white paper to an actual block chain technology and a coin that starts to appreciate in value almost immediately?

VIGNA: So what the white paper was describing was a computer program and that the goal of the computer program was to create this digital money, this peer to peer electronic version of cash.

So he releases a white paper in October 2008 and puts the program online.

RITHOLTZ: So he sets up the program, it was more than a white…

VIGNA: It was more than a white paper, it was a paper describing what he was doing — he wrote the program too, puts the program online in January 2009 as an open source project where anyone is open to participate in building it.

RITHOLTZ: So let’s describe that. So building the software or building the coins themselves.

VIGNA: Well, the software.


VIGNA: So you know he releases version 0.0 Bitcoin and what he is looking for are collaborators, he’s looking for people to come on and help develop the program. In other words, again, you know, a company like Microsoft like Apple whatever, they have teams of developers…

RITHOLTZ: Thousands.

VIGNA: Yes, thousands. This is a different kind of version of that. You’re talking about developing a software program but you’re looking for collaborators like…

RITHOLTZ: Like Linux and those sort of things…

VIGNA: Linux is a great example of an open source program so that’s what he releases and again, it’s very key I think that you mention this is all happening during the financial crisis.


Mount Stupid (Again)

Source: Saturday Morning Breakfast Cereal



Two weeks ago, I discussed the importance of understanding how much I know (or do not know).  As noted then, “I pay lots of attention to meta-cognition, and how when we develop skills we also learn the separate skill of self-evaluation. This is of enormous importance to traders and investors; I find it fun to bring in parallel experiences from other realms.”

I enjoy meta-cognition as much as the next wonk, and have written about Dunning Kruger too many times to count. However, nothing beats the succinct phrase “Mount Stupid.”



Mount Stupid (June 3, 2015)

Meta-Cognition: Understanding How Much I Know or Do Not Know

Source: Both Sides



I love this Simon Wardley chart above, found via Mark Suster.

It is richly filled with insights from psychology, with Dunning Kruger’s concept of meta-cognition as a skill, and just for fun, the Socratic paradox of “The only thing I know is that I know nothing.”

This is worthy of a longer exposition, which I will attempt once I recover from the minutia of USPS health care legislation; for now, a quick few thoughts.

I pay lots of attention to meta-cognition, and how when we develop skills we also learn the separate skill of self-evaluation. This is of enormous importance to traders and investors; I find it fun to bring in parallel experiences from other realms. Recently, it has been radio and tennis. Both are interests I have come to late in life, starting each in my early 50s, with no background in either.

Tennis is hard, as anyone who watches the U.S. Opens can see. I was surprised to learn Radio was even harder.

To succeed at tennis, you need to master a series of technical mechanics, along with timing, footwork, proper distance, eye-hand coordination, mobility and an intriguing mental game. As someone who has always had issues with proprioception (I am a klutz), these physical mechanics are challenging.

When a project is progressing too slowly, seeking out expert help is advised. So I did.

Going slow to go fast applies to driving fast on a race track as well as playing tennis well. I learned that it is not merely about hitting the hardest or being the fastest to the ball. I was terrible two years ago, but via a helpful former pro player, a few modest technical changes made me significantly better. The mechanical body positionings made my forehand better, I developed a backhand (where previously I had none) a drop shot and slice shot came along, and the beginnings of an actual serve appeared. I was much, much better than before.

But this is not to say I was any good. What was most shocking to me was as I improved, I came to realize how truly terrible I was. Where previously I imagined myself to be a 4 or 5 on a scale of 10, my improvements came with lowered self-rating. Am I a 4? No wait a 3, no, worse, barely a 2.

Understanding meta-cognition abstractly was one thing, but living it was an entirely different thing.

Radio was much worse.

The idea behind Masters in Business was always pretty simple: find intelligent, successful people, and rather than ask them ephemeral nonsense – “What’s your favorite stock, when will the Fed raise, where will the Dow be in a year? – have instead an adult conversation about who they are and how they got that way.

My assumption was the content alone would be sufficient. Hey, how hard is it to talk? We do it every day. It took about 30 shows to disabuse me of that notion.

Al Mayers was Bloomberg’s head of radio. Each week, he would patiently pull me aside and deconstruct the last show – explain interviewing tactics, listening skills, how to pick up subtle things the guest said and then follow up. It was a crash course at not sucking at radio.

Almost 4 years later, and nearly 200 shows, and I can honestly say I have improved from thinking I was a 5 when I was really not quite a 2, to becoming a 6 with occasional glimpses of 7 or 8. This is not artificial humility – if you ever get a chance to watch Tom Keene in the radio studio do a dozen things at once, live on the air, without making an error, you will be in awe. I now know exactly what achieving that level 10 looks like and how much more there is to go to get there.

As always, there are life lessons and investing skills to be pulled from these experiences.

What do you erroneously believe you are great at?


Go on the Daily Show!

Last week, we had the announcement of the end of Jon Stewart’s run on The Daily Show. I had been saving this column for the next TDS disaster, but rather than hold it, I decided to set it free. Enjoy.


A few months ago, my fellow Bloomberg View columnist Megan McCardle anticipated just such a [insert disaster here]. She admonished “Don’t Ever Appear on ‘The Daily Show” warning readers that they will “look like an idiot on the show.”

I think this advice confused cause and effect.

Why? It is not that:

You should not go on The Daily Show because you will be made to look like an idiot.

The proper If/Then clause is reversed. Rather:

IF you are in fact an idiot, THEN you should not go on The Daily Show.

This is a very significant difference, one that has repercussions for anyone considering making an appearance on this (or any other) show. My advice may be more nuanced, but it is the more useful for reasons I detail below.

Let me preface this with a few details: 1) I am not, all appearances to the contrary, actually an idiot (my wife begs to differ); and 2) I actually have been on The Daily Show.

Hence, I present these thoughts not as theoretical abstract, but based on real world experience being a guest on the show. For me, it was a fantastic experience, one that I would not recommend skipping for anything.

Unless you are an idiot. More on that below.

If you are invited to appear on TDS, or Colbert The Nightly Show, or Real Time or any show that mixes comedy with policy, some common sense edicts apply. You should understand how television gets made (its similar to the way sausage gets manufactured). You should be aware of the danger of backfiring when pushing against any show’s culture or ethos. If your own ideology clashes with that of the writer/producer/host, expect pushback. And the importance of having some humility when going on shows such as this cannot be overstated.

Thus, my job today is to provide you with a short set of guidelines for appearing on television. For those of you fortunate enough to be asked to appear on The Daily Show, consider this your pre-appearance media coaching.

First, some background on my experience: I had written a column for Bloomberg View about how McDonalds and Wal-Mart had become welfare queens. They had been gaming the safety-net of Medicaid, food stamps and aid to dependent children in order to shift their corporate labor costs onto the taxpayer. McDonalds even set up a “McHelp line” to walk their minimum wage employees through the process of getting as much government aid as possible. An email came in from one of the producers, and that started a discussion which ran for several weeks. A month later, we filmed my part in my office; the segment was broadcast several months later.

All told, it was a terrific experience – including the spit take from Samantha Bee. But it was not without controversy, and from my experiences, I would suggest a different set of rules from that of my fellow Bloomberg View columnist. Use these questions as your guideline to appearing on The Daily Show:

1) Why do you want to go on TV in the first place?

No one seems to ask this fundamental question, but really – why would you, as a rational person, want to go on TV in the first place? It is bizarre that in the modern age of celebrity, it has somehow become a badge of honor. Where I totally agree with Megan is that if you do not have a compelling reason to go on TV – a foreign world with its own rules and mores, fraught with potential danger – then don’t do it.

Don’t go on just to be on.

If you run a business where broad exposure to the public is a good thing (check!) or engage in a regular debate of ideas (check!), then perhaps some face time on TV might hold some lure for you. Just understand exactly what you are getting into.

2) Don’t go on the Daily Show if you are an idiot.

This is an obvious admonition, but if you watch the show, you know it is continually ignored. Many of you are idiots – not TBP or Bloomberg View readers, of course, but you, the idiot who was forwarded this column from his trader brother-in-law. You may be an idiot, and if that’s the case, you should not go on television at all!

Indeed, the rest of us would appreciate it if you never went out in public, for the world is chock full of way too many idiots.

Here is a fascinating aspect to Rule #2: It will be widely ignored by idiots because part of being an idiots includes being wholly unaware of their own lack of intelligence. This meta-cognition is technically called the Dunning Kruger effect. It means that people who are not especially competent at a given task have no idea of their own lack of skills at that task. Self-assessment is a skill that primarily comes with expertise. It applies to everything: Driving, golf, singing, investing, even one’s own intellectual capacity.

So if you are in point of fact, an idiot, you are most likely wholly unaware of this simple truth. Hence, you should definitely follow Megan’s advice and NOT go on the Daily Show

But the odds are that you will ignore both of our advice if you are ever asked – you will appear on the show. The end result will most likely be hilarious. This is why idiots keep getting asked to appear on shows like TDS: For mockery and our entertainment pleasure. As much as I advise you otherwise, please, don’t ever stop.

3) Avoid sharing intellectually indefensible ideas and ideologies

Too many people remain married to ideas that have been thoroughly disproven. Rather than accept established facts and adjusting their perspectives, they choose instead to discard reality to preserve their own discredited belief system.

This is known as Cognitive Dissonance. And it is an incredibly easy thing to make fun of on television.

Whether believing that tax cuts pay for themselves (Howdy, Kansas!) or not being willing to admit evolution is a thing (Scott Walker, come on down), or fighting marriage equality, or taking absurd positions on global warming, or just about any other BenSteinery you care to engage in, you will be eviscerated on The Daily Show. Their writers are sharp, Jon Stewart is lightning quick, and besides – viewers appreciate that you deserve it.

4) Don’t say anything terribly stupid

This should be obvious, but over the course of a long shoot, stuff can slip out. The person on the other side of the minimum wage debate from me in my segment was Peter Schiff. I know Peter, and I can tell you he is not an idiot; in fact, he is a smart guy. But then he said something terribly foolish on air: “What’s the politically correct word for mentally retarded?

I am not the most politically correct guy in the world, but as soon as I saw that, I knew he was toast. I just imagined the segment producer’s eyes, popping out of the her head cartoon-like with dollar signs on them, as a big Ahh-HOOOGAH sound blared in the background. That line was game over.

Shiff’s faux pas cost me most of my screen time. But it also meant that I was not going to be the guy who got eviscerated. It is a good rule of thumb: Do not say anything especially foolish.

5) Have something worthwhile to say

This should be obvious, but gets overlooked. In the segment on minimum wage, I thought it was worthwhile pointing out several important things: The minimum wage had not gone up for many years; adjusted for inflation, it should have been closer to $11 per hour, many economic studies had shown that raising the minimum wage does not hurt the local economy, and did not reduce employment, etc. The McDonalds welfare help line was offensive, as was gaming their compensation package to max out their government dole. Also of note: Walmart employees, as a group, are often the biggest Medicaid and food stamps recipients within each state where they have many stores.

All of that just seems wrong. These are all worthwhile subjects for discussion. Risking a little personal humiliation to debate the important issues of the day on a widely seen national television show was worth it to me.

6) Don’t relax

The day the show was set to air, I wrote the following: “Over the course of two hours, its pretty easy to say something stupid — especially when one of the funniest people on earth is two feet away making faces and saying very funny things. I hope I didn’t embarrass myself. We’ll find out at 11:06pm or so.”

Indeed, this is the advantage of doing live television over anything recorded and edited. (Megan is dead right about this one, too). I have done other shows like Nightline, where they have a script, and it is the producer’s job to get you to say something that follows their narrative (not yours). After you are asked the same question in a slightly different way for the 6th time, it is easy to slip up and say something you don’t believe. My response is always: “Asked and answered, next question” after multiple attempts to get me to say something against my own beliefs on Nightline.

7) Save Yourself with an F-Bomb

I have a little secret I’ve learned on the rare occasions I do any prerecorded shows: If I really don’t like the way something I am saying is coming out, I drop several F-Bombs into the rest of the sentence, thus rendering it useless for most news shows.

NOTE: This will not help you on the Daily Show.

8) Have a sense of humor about yourself.

I agreed to be part of a spit take that Samantha Bee did. It was great fun, and if you watch the segment, you can actually see me leaning forward to grab a paper towel for her from my desk drawer. I barely got wet, but she soaked herself.

Regardless, you have to have a sense of humor – and some humility – about yourself. Getting spit on by one of the funniest women in the world seemed like a fair exchange.

Those are my suggestions. Don’t be an idiot, don’t say anything terribly foolish, don’t have indefensible ideological ideas, keep your wits about you, and be humble.

If you can follow those rules, then, yes, you should go on The Daily Show.


How’s Your MetaCognition?


“Knowing yourself is the beginning of all wisdom.”



Over the past few weeks, I have been waxing eloquent on the subject of self-awareness, knowledge, and recognizing one’s own lackings thereto. Last week, we discussed the Value of Not Knowing; that followed the prior week’s discussion of why I don’t bother guessing a monthly NFP number.

Today, I want to discuss Self-Enlightenment — why understanding yourself is so important to investors. This isn’t a Zen discussion of achieving a higher sense of oneness with the universe; rather, it is an explanation as to why knowing what it is you actually know, understanding what you don’t know, and having a high level of recognition of the danger when you think you know (but really don’t) is so crucial.

Those of you have seen our “Brain on Stocks” presentations know that MetaCognition is an important part of understanding. You also know that a significant part of expertise is the intense understanding of one’s own skills and limitations. The other side of Dunning Kruger effect — which we have discussed repeatedly — is that the amateur and the unskilled participant are stunningly unaware of their own inferior knowledge and skill set. They do not know what they do not know — often, fatally so.

So perhaps the best question we can ask of an investment manager (or an investor can ask themselves) is not “How Smart Are You?” Rather, it is “How’s your MetaCognition?” How self-enlightened are you? How well do you understand what you don’t know?”

From Socrates to Plato to Aristotle, metacognition was an important part of Greek philosophy. Socrates perhaps most famously declared “I only know that I know nothing;” He was perhaps the first human to wax eloquent on metacognition. It may be counter-intuitive, but understanding one’s own ignorance is the first step to attaining knowledge.

Perhaps Shakespeare put it best in As You Like It: “The fool doth think he is wise, but the wise man, knows himself to be a fool.”

How’s your metacognition?


On the Value of Not Knowing

Its Philosophy Phriday, and as such, I want to discuss my ignorance. Or rather, my justifiable pride in my willingness to say “I don’t know.”

I use this phrase frequently, for there are a wealth of subjects I know very, very little about.

Sometimes I am asked things I could not possibly know, particularly about the future. Rather than guess, I believe the best approach is to admit the truth, then plan accordingly. The alternative is to do what too many people do: Make predictions, then marry those forecasts. This usually leads to catastrophic results.

Understanding what it is I do not know is a core part of my approach to the world. Its why I focus so much on investor psychology and cognitive issues. I want to understand what I don’t know, and what my brain is essentially lying to me about. I believe this approach is rewarding.

You may be somewhat surprised to learn that this is not standard operating procedure for most people in many fields. Perhaps we might blame this failure to admit ignorance on an excess of testing children, who are taught to regurgitate some answer regardless of whether they know its correct or not — but (heh heh) I do not know the actual cause.

In the world of investing, recognizing what you do not know and therefor should not be betting on is paramount. It is an important trait for an investor/asset manager to own. Too many people assume they are making decisions based on what they know, but oftentimes their decisions are based on what they think they know but really don’t.

I am not trying to be cagey or contrarian for its own sake — although I will admit to a dollop of mischievous joy when I watch a TV news anchor’s face when I respond appropriately to a foolish question:

Q: “Where is the Dow going to be one year from mow?”

A: “I have no idea.”

Q:   ( *Twitch* )

Everyone who answers that question with anything other than “I don’t know.” is mostly lying. They DO NOT know, and even worse, they are often unaware of their own ignorance (see our prior discussions on Dunning Kruger effect).

Perhaps worst of all, they mislead the viewer into thinking that they, the expert, does know and that you, the home viewer, does not . . . and therefore, you should BUY MY PRODUCT.

That twitch is not why I answer the way I do (tho its a small reward); Rather, it is the proper answer. It is a reflection of accepting a simple reality denied by (IMHO) 4 out of 5 people in my industry.

There are tremendous advantages in recognizing what you do not know. Acknowledging shortcomings in your informational intelligence is a form of situational awareness that prevents you from being blindsided.

There are other benefits as well. It shifts your focus to process over outcome; it assists you in understanding what is the result of skill and what is dumb luck. It prevents you from being fooled by randomness. And as we have learned, repeatable results that are the result of a process are vastly superior to random outcomes.

This is a more valuable trait, a reflection of a more insightful set of perspectives than you might realize. Some branding experts have (more or less) stated that “You have moved into the niche market of Truth ever since the larger firms abandoned it for more lucrative fields.” Alas, no, this is not marketing schtick. It is a simple acknowledgement of reality, which leads to smarter planning and superior outcomes. It might be more challenging to sell to people — it ain’t slick, does not lend itself to glossy brochures, is hard to manifest in a tagline — but it works.

What are you ignorant about?



Metacognition & Self-Confidence

Why incompetent people think they’re amazing



David Dunning wrote this for Pacific Standard:

In 1999, in the Journal of Personality and Social Psychology, my then graduate student Justin Kruger and I published a paper that documented how, in many areas of life, incompetent people do not recognize — scratch that, cannot recognize — just how incompetent they are, a phenomenon that has come to be known as the Dunning-Kruger effect. Logic itself almost demands this lack of self-insight: For poor performers to recognize their ineptitude would require them to possess the very expertise they lack. To know how skilled or unskilled you are at using the rules of grammar, for instance, you must have a good working knowledge of those rules, an impossibility among the incompetent. Poor performers — and we are all poor performers at some things — fail to see the flaws in their thinking or the answers they lack.

What’s curious is that, in many cases, incompetence does not leave people disoriented, perplexed, or cautious. Instead, the incompetent are often blessed with an inappropriate confidence, buoyed by something that feels to them like knowledge.

-PacificStand, We Are All Confident Idiots

Jason Kottke sums this up by saying: “Confidence feels like knowledge. I feel like that simple statement explains so much about the world.”


Do you know what you don’t know?

A Tweetstorm That Every Investor Should Read
A Wall Street veteran makes the case for acknowledging our ignorance.
Bloomberg, May 11, 2018



Yesterday, James O’Shaughnessy posted a long and intriguing tweetstorm about investor ignorance. Jim is the chairman and founder of O’Shaughnessy Asset Management LLC,1 and the author of the classic investing book “What Works on Wall Street.”

The entire thread is worth reading from start to finish, but here is the beginning:

This post, as regular readers know, is about one of my favorite subjects. To be more precise, it is about our own lack of understanding of our own lack of understanding. From the original work by Daniel Kahneman and Amor Tversky, as laid out in their famous 1974 paper “Judgment under Uncertainty,” to the Dunning-Kruger concept of metacognition — the specific skill needed to recognize one’s own skill set — this foible continues to be of great importance to investors. O’Shaughnessy starts his discussion on a note of humility, writing there are “some things I think I know and some things I know I don’t know.” That simple observation places him ahead of oh, say, 80 percent of all investors. This is not how way too many investors think.

The first step is recognizing what it is you know you don’t know. For O’Shaughnessy, this begins with the simple question, one that is asked every day by financial journalists in print and especially on television, discussed among retail stock brokers, and debated by fund managers: How will the market perform this year or next? This is often paired with a related question: Will stocks be higher or lower in five or 10 years? O’Shaughnessy notes what the probabilities are — stocks do tend to rise over time — but then says he can’t say with any degree of certainty if stocks will indeed be higher a decade from now. 2

This acknowledgement alone bumps him up to the 90th percentile of wisdom among investors.

Most people don’t even try to envision what they don’t know. This brings to mind, of course, that felicitous phrase coined by former U.S. Defense Secretary Donald Rumsfeld, “unknown unknowns.” The human brain, marvelous as it may be, has a blind spot for these. But, truth be told, the universe of what we don’t know is beyond our grasp, even though we tend to fool ourselves into thinking we know more than we do.

This brings to mind something Rob Brotherton, an academic psychologist,  described in his book “Suspicious Minds: Why We Believe Conspiracy Theories.” Citing University of Michigan professor David Dunning, half of the duo behind the Dunning-Kruger effect, he wrote:

An ignorant mind is precisely not a spotless, empty vessel. It’s filled with information — all the life experiences, theories, facts, intuitions, strategies, algorithms, heuristics, metaphors, and hunches — our brain indiscriminately uses whatever is at hand to plaster over the intellectual blind spot.

This is an enormous problem, not just for those who believe that the moon landing was faked, but for investors as well: indiscriminately plastering over the “intellectual blind spots” leads to terrible outcomes in markets. Our lack of awareness of our ignorance may be the enabling cognitive bias that leads to all other investment errors.

That raises some questions all investors should ask themselves from time to time. The second most important is “What am I wrong about?” while the most important is “What do I have no idea I am wrong about?”

The trends of the past decade strongly imply that investors are starting to not only understand this, but change their own behavior in response.

I believe that sending trillions of dollars to low-cost index funds run by Blackrock Inc. and Vanguard Group Inc. is a sign that investors are growing more aware of their cognitive limitations. It indicates, to borrow from Rumsfeld again, a Known Knowns: That costs matter, and that as a rule of thumb, the lower the fee the better the long-term performance. Generally speaking, passive is much cheaper than active.

Investors have also come to recognize their own inability to pick outperforming money managers — a “Known Unknowns.”. Last, the financial crisis of 2008 also taught us that nearly all people lack the ability to anticipate how they themselves will respond in the future to unknown market conditions — this is a “Unknown Unknowns.”

O’Shaughnessy wraps up his tweet storm by noting “While I think I know that everything I’ve just said is correct, the fact is I can’t know that with certainty . . . history has taught us that the majority of things we currently believe are wrong.”

Admitting the possibility of not knowing something, recognizing how much we are ignorant of, is the first step toward preventing the kinds of overconfidence and assumption of omniscience that is so damaging to investors.


1. Disclosure: Some clients of Ritholtz Wealth Management are invested in O’Shaughnessy asset management funds.

2. Although the philosophical implications of this are intriguing, the data geek in him can’t avoid the numbers: “Since 1945, there have been 77 market drops between 5% and 10% and 27 corrections between 10% and 20%.” O’Shaughnessy notes this is a “feature, not a bug” of markets.


Originally: A Tweetstorm That Every Investor Should Read