Richard Thaler was just awarded the 2017 Nobel Prize in Economics for his work in the irrationality of human decision making. If you were to now re-read his 2009 best seller Nudge : Improving Decisions About Health, Wealth, and Happiness and compare it with Joel Tillinghast’s 2017 book Big Money Thinks Small, you would see a few common themes between these pieces that we would like to explore.
Fundamentally, both of these men (who manage over $40B currently) embrace the Two System thinking of Daniel Kahneman. This complex analytical versus reflexive gut decision making processes are a core issue in avoiding the madness of crowds, and Thaler’s book goes into depth as to how to use the architecture of choice to improve outcomes, something that has great real-world application.
How significant are the effects of this architecture of choice? A recent calculation by Bernartzi shows it to be around $30B of additional retirement savings in the past decade. From changing annual default options to the order and number of allocations within a plan, the understanding of inertia as applied to Humans (as opposed to physical bodies per Newton or assuming everyone is emotionless rational beings with all the free time needed to analyze choices like Econs would assume), Thaler’s work has had a direct impact on the investing public. It does not take a Nobel Prize winner to see that an additional $3B a year flowing into the markets will have an effect.
Libertarian Paternalism and Nudge
The concept of Libertarian Paternalism Thaler espouses throughout Nudge has the potential to rub many the wrong way instinctively, but the moment one engages the Reflective System (higher orders of thinking as opposed to gut reaction), it is fairly clear the beneficial applications across many industries and organizations. Being investment focused, let’s explore the application to our world particularly.
We all have the instant gratification need in us, that wants donuts a la Homer Simpson (the example of Thaler) and makes snap decisions. Good for survival in the pre-agrarian days, not so much in our information society because of the changing risk reward dynamics from “don’t get eaten” to “make profit on trades”. So how do we adapt as we are still bound to our evolutionary roots?
One way is applying the Planner concept. Plan ahead like Odysseus filling his ears with wax to hear (but not succumb to) the Syren’s Song, when you can be as logical and detached as Mr. Spock. The Planner can be an accountability buddy like for your workouts that is willing to poke holes in your thesis. It can be a hard and fast screening tool, that can knockout your ideas if they are too far afield. Maybe your Planner is Ben Franklin’s T Bar analysis. Find something (or a combination) that works within your strategy and tendencies and apply it. Remember that this goes for sell side as well as buy side, as too often inertia sets in and we believe that the bull will keep running because it has been doing so. Not falling in love with your picks is hard and important.
Another way to limit your inner Homer (“But I’m angry NOW!”): set a timer for five minutes and grab a piece of paper whenever you want to make an emotional or knee jerk action. Write down every reason why doing so is wrong that you can think of in that five minutes. Then ask yourself if you should still do what you were thinking of. Helps to balance your beliefs.
What about answering this question: I would defend this choice to my Board (or Investment Committee) by…and write the few sentences. Then do a QnA within your head as if you were being grilled by your bosses before they sign off on the action. This harkens back well before Thaler or even Kahneman to The Art of War by Sun Tzu: the successful General does a thousand calculations before marching out to battle. Thinking slow is not a new phenomenon.
If you were to reflect upon the Two System thought concept for a few minutes, it might become clear that using the Reflective, slow thinking is an ideal way to overcome the adage that markets are moved by fear and greed. Clear, logical thinking like Spock (or GeoInvesting as Info Arb specialists) allows the madness of crowds to be less seductive and create opportunities for those with mental discipline to resist the short-term desires of the markets and emotions.
Thank you for taking the time to think about this subject. If you were to have found this valuable, you might want to try the trial offer from GeoInvesting to see how much more profitable we can be to you.
written by Joseph RR Templin for GeoInvesting