His main points are:
“No. 1: We seek information to reinforce our beliefs.
No. 2: Selective perception prevents us from becoming fully informed.
No. 3: The ability to step out of ourselves to see the world from a different angle or perspective is hard.
No. 4: Emotions get in the way.
No. 5: Objectively measuring data isn’t our strong suit.”
While Ritholtz‘ point here is that our brains get in the way of making good investment decisions, the same clearly holds true for risk. In fact, looking at four of his five points, I would argue that the reality of human decision making is even worse than he says.
First, do we seek information that reinforces our belief that our investments are safe? Well we certainly don’t seek out the opposite. How many people who owned highly leveraged housing in the mid-2000’s comforted themselves with the knowledge that real estate “never goes down”? A bit of research in 2005 would have turned up three national level real estate declines of more than 20% in past 100 years. Looking on the local level, one would have found at least four significant, regional declines. All this was in the record before 2008, but how many people looked?
Selective perception is even more dangerous in assessing risk. Large losses in many asset classes occur at lower frequencies than gains. So any selective perception decreases our already limited ability to see risk.
I’ll skip point three, as it is well-covered in the article.
As to point number four, emotions getting in the way, this is, again, even more true for evaluating potential losses. Thinking about losing is uncomfortable, so we don’t do it. How many spouses don’t buy life insurance, not because they don’t love their families, but because they don’t want to think about death? (The answer: lots.)
Finally, his point about objectively measuring data is true, but I think it understates the point. Even if you are scrupulous in looking at all the past data regarding any given decision, you only see what has happened. You don’t see what could happen. And the worst that could happen is almost always far worse than what has happened.Even if ur scrupulous looking at all past data, you only see what has happened-not what could. And… Click To Tweet