It costs you $1.10 to buy a bat and a ball. If the bat costs one dollar more than the ball, how much does the ball cost?
That’s the question with which Robert Hagstrom led off chapter nine, the final chapter, of his book “Investing: The Last Liberal Art.” The chapter is about decision-making, which means, in part, identifying the reasons why we make bad decisions.
In the case of the bat and the ball, many of us immediately answer that the ball costs 10 cents. But, in doing so, we have misled ourselves. The difference between $1 and 10 cents equals 90 cents, not one dollar. The reason why so many of us got it wrong is that we relied on our “intuition” rather than our “reason.”
Shane Frederick, a marketing psychologist at Yale University, developed that problem as part of the Cognitive Reflection Test. He explained that intuition produces “quick and associative” cognition, while reason is “slow and rule-governed.”
Psychologist and academic Daniel Kahneman, a Nobel Prize winner in economics, believes there is a place for intuitive thinking—when two conditions are met. First, when the environment is reasonably regular and predictable, and second, when a practitioner has had an opportunity to learn these regularities with plenty of practice. Think of doctors and nurses, firefighters and pilots.
In more complex environments, however, practitioners are less likely to develop their intuitive skills. This group includes stock pickers and economists. It was Kahneman’s belief that minds transition from intuitive to reasoned thinking when knowledge increases.
But don’t let Kahneman’s optimism lead you too far. Hagstrom also introduced his readers to Philip Tetlock of the University of Pennsylvania. He tracked the predictions of 284 experts between 1988 and 2003; experts in this case being people who were quoted on television, in newspaper and magazine articles or who advised businesses or governments.
Altogether, they made more than 27,000 forecasts. Tetlock tracked every one of their predictions and concluded their expert predictions were no better than “dart-throwing chimpanzees.” According to Tetlock, “How you think matters more than what you think.”
For another perspective, Hagstrom turned to Sir Isaiah Berlin and his famous essay on hedgehogs and foxes. The metaphor came from the ancient Greek saying, “The fox knows many tricks, the hedgehog only one.”
Berlin’s essay divided writers and thinkers into two camps. First, the hedgehogs, whose world view is based on one defining idea; second, foxes, who discounted grand theories and instead depended on a wide variety of experiences in making decisions.
Among those who read Berlin’s essay was Tetlock. He divided his expert forecasters into two groups: hedgehogs and foxes. And although the overall performance of all forecasters was poor, those in the fox camp did significantly better than those who behaved like hedgehogs.
What’s the difference? Tetlock explained it by noting that the hedgehogs often fell in love with their pet theories, something we might otherwise call tunnel vision. They were also slower in changing their views when those existing views proved to be wrong.
In other words, foxes are employing Bayesian analysis more quickly. Further, you may recognize Bayesian analysis is an evolutionary approach to updating knowledge. Hagstrom added:
“Foxes stitch together a collection of big ideas. They see and understand the analogies and then create an aggregate hypothesis. I think we can say the fox is the perfect mascot for the College of Liberal Arts Investing.”
The next thinker up was Keith Stanovich of the University of Toronto, who argued that intelligence tests are poor barometers of rational thought. He coined a new word, “dysrationalia,” to describe why some people do not think or behave rationally, even though they are highly intelligent.
In his research, people used the least effort possible when making decisions, they are “lazy thinkers.” In light of our previous discussion, we might say humans are inclined to use intuition rather than reason to solve their problems.
One cure for that, according to cognitive scientist David Perkins of Harvard, is to be aware of the “mindware” gap. Mindware refers to the rules, strategies, procedures and knowledge people can draw on to solve their problems. Perkins wrote, “A piece of mindware is anything a person can learn that extends the person’s general powers to think critically and creatively.”
He also argued that mindware gaps occur because people don’t receive broad educations. While schools may teach the facts in each discipline very well, they don’t connect the facts of different disciplines. He called for a “metacurriculum,” a higher order curriculum that addresses good patterns of thinking.
Bringing the content of this book full circle, Hagstrom wrote:
“So now we come around to the heart of the matter. Perkins’s hope for a new way of learning perfectly aligns with the underlying principle of this book—that people studying the art and science of investing are best served by incorporating the “rules, strategies, procedures, and knowledge” from several different disciplines. In this regard, Investing: The Last Liberal Art is a direct example of a mindware booster shot.”
With that, Hagstrom begins winding up the chapter and the book. Like Charlie Munger (Trades, Portfolio), he believes we can become better investors by studying “big ideas” from other disciplines. And, indeed, he has introduced us to big ideas from multiple disciplines, then applied those ideas to the art and science of investing.
To put it another way:
“My hope with this book is that it will inspire you to begin thinking about investing in a different way, as something more than a kaleidoscope of shifting numbers. But thinking about investing differently means thinking creatively. It requires a new and innovative approach to absorbing information and building mental models.”
Read more here:
- Ă‚ Learning to Think Like Charlie: Mathematics Part 2
- Ă‚ Learning to Think Like Charlie: Mathematics Part 1
- Learning to Think Like Charlie: Literature and Critical ThinkingÂ
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