Daniel Kahneman, the Princeton professor of psychology, who won the Nobel Prize in economics for his pioneering work in behavioral finance passed away last week. Here’s an obituary by Jason Zweig, the noted financial journalist who had a chance to observe Kahneman from close quarters when he worked on the initial drafts of Kahneman’s best selling book, Thinking, Fast and Slow.

“Before the pioneering work done by Kahneman and his research partner, Amos Tversky, who died in 1996, economists had assumed that people were “rational,” meaning we are self-interested, use all available information to make unbiased decisions, and our preferences are consistent.

Kahneman and Tversky showed that’s nonsense.”

Zweig goes on to say: “Kahneman may well have had more influence on investing than anyone else who wasn’t a professional investor.”

Zweig may not be too wrong with that statement as Kahneman’s work went on to explain the irrationality of investors:

“Why do we sell our winners too soon and hang onto our losers too long? Why don’t we realize that most hot streaks are just luck? Why do we say we have a high tolerance for risk and then suffer the torments of the damned when the market falls? Why do we ignore the odds when we know they’re stacked against us?”

Kahneman’s greatest insight about human behaviour was our loss aversion, a cognitive bias:

“…money lost isn’t the same as money gained. Losses feel at least twice as painful as gains feel pleasant. He asked the conference attendees: If you’d lose $100 on a coin toss if it came up tails, how much would you have to win on heads before you’d take the bet? Most of us said $200 or more.

…Ask people if they want to take a risk with an 80% chance of success, and most say yes. Ask instead if they’d incur the same risk with a 20% chance of failure, and many say no.”

Zweig ends the obituary with this piece showing how self-aware the Professor was about this human limitation:

“Danny also insisted that studying the pitfalls and paradoxes of the human mind didn’t make him any better at problem-solving than anybody else: “I’m just better at recognizing my mistakes after I make them.”

For all his knowledge of how foolish investors can be, Danny didn’t try to outsmart the market. “I don’t try to be clever at all,” he told me. Most of his money was in index funds. “The idea that I could see what no one else can is an illusion,” he said.

“All of us would be better investors,” he often said, “if we just made fewer decisions.”

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