Daniel Kahneman: The Trouble With Confidence

Johnny HopkinsDaniel Kahneman, Investing PsychologyLeave a Comment

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Here’s a great little video by Daniel Kahneman on the trouble with confidence. Kahneman makes the point that from a societal perspective confidence is generally very good, but from an individual’s point of view confidence is typically not always good.

Here’s an excerpt from the video:

Society rewards overconfidence. We want our leaders to be overconfident. If they told us the truth about the uncertainty we would discard them in favor of other leaders who sort of give an impression that they know what they’re doing.

We want overconfidence. We support it, we sustain it and there is an awful lot of it.  Most of what we read in the paper is overconfidence. Sometimes it’s catastrophic. Just about every war that you see, I think that’s a general rule, there are optimists among the generals and there are optimists on both sides and that is true for a lot of litigation as well.

So a lot of conflict is fed by overconfidence. There is an interesting story here of two biases that work in opposite directions. So one familiar, you can call it bias, but is what we call loss aversion. People put a lot more weight on negative events than on positive events. On loses than on gains.

So that’s one principle. If people are to gamble many on the toss of a coin and they stand to lose $100 they will demand more than $200 to accept the gamble which is in some ways is ridiculously risk-averse. So people are loss averse. On the other hand they’re optimistic, and so many of the decisions that people make especially in starting new businesses. That is where it’s been studied most extensively. People think they will succeed.

They open a restaurant because they think they will succeed. But in fact less than 1/3 of small businesses survive for five years. So clearly overconfidence is rife and overconfidence and loss aversion seem to be acting in opposite directions.

You have to distinguish the perspective of the individual from the perspective of society. I think for society it is probably very good that we have a lot of optimistic entrepreneurs who think they will succeed, although most of them fail. Most of them really do not know the odds.

It is not true that they know the odds and they take the risks willingly but many of them, most of them probably do not know the odds.

From the point of view of the individuals it is not always good to be optimistic. For example I have no interest whatsoever in my financial advisor being an optimist. I don’t care for that. For an entrepreneur it may be a good thing to be an optimist because it will make him or her persevere more.

We know that being an optimist is useful under some conditions. It is not always useful in making decisions.

You can watch the video here:

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