The Curse of Knowledge
There are many difficult decisions to make when considering an investment in a particular business. Sometimes the more information we have the harder it is to make an accurate decision, we fall victim to what some may know as the “curse of knowledge.”
I recently read a few various experiments pertaining to the curse of knowledge and how it impacts our judgment that I would like to share. First when we are solving a problem, there is an ability to use as many variables as we can identify, believing this will bring us a more accurate answer. Think about the last investment you made and contrast that with how you catch a ball. Both include many different variables that we can identify such as the velocity of the ball, the trajectory of the ball, the mass of the ball, our speed, arm length, hand size, and I am sure you get the point.
Instead we use what some may know as a “gaze heuristic” to catch a ball, the same tactic dogs use to catch Frisbees and falcons use to target prey. When a ball comes in high, a player starts running and fixates his eye on the ball. The “gaze heuristic” is that you adjust your running speed and keep the angle of the gaze constant, which is in the middle of your view. If you do this than all you have to do is finish, putting your mitt or hand out to catch the ball or you will take it off the head.
As you can see, you only pay attention to one variable, keeping the angle constant with the ball in the middle of your vision. This video is an example of a falcon using the same heuristic in action.
The is a smart heuristic that we have used to adapt and survive over the years, as the brain structures our environment into a simple linear problem. Another experiment that I found fascinating was identifying cities in Germany and America.
First the Americans are asked to identify which German city has a higher population, Hanover or Bielefeld? When it came to the Americans, over 80% said it was Hanover, which is the correct answer but the Germans had a more difficult time because they had heard of both cities and began to try and recall facts. The same experiment was inverted with the two cities San Antonia and San Diego, this time the Germans had a 99% accuracy rating while only 66% of Americans answered correctly. This again is because of the “curse of knowledge”, as the people who are familiar with what is being asked tend to overthink the situation. The answer is San Diego.
Finally the last experiment I would like to share, relates to the stock market. There was four funds assembled, (1) Randomly Picked Stocks (2) Fidelity blue chip fund (3) Dow Jones (4) Least recognized stocks from a survey conducted of the S&P500 (5) Most recognized stocks in the survey conducted of the S&P500.
As you might have guessed already, or known before, is that the most recognized stocks outperformed all other categories. So why does any of this matter?
Intrinsic Value, Margin of Safety and Don’t Lose Money
These are our smart heuristics, we focus on them relentlessly just like the falcon and his prey, but instead we are targeting large discounts. We don’t need to worry about a large portion of other things if we can get our estimates close to the actual outcome; when this occurs, we are in a position to future harvest our past sowing.
Everyone has heard Warren Buffett (Trades, Portfolio) say “Rule number one: Don’t lose money, Rule number two: Follow Rule One.”
Have you thought of the true implications and math behind this statement? Most people have, I will spare you the repetition.
And another famous quote,
“You only have to do a very few things right in your life so long as you don't do too many things wrong.”
We need not focus on as many moving parts as we can identify but rather the important ones. The curse of knowledge does not take kindly to additional variables if they are not used correctly and it is usually best to use only a few of the most important variables when formulating a decision.