The Five Minute Read: You Are Not So Smart

In this week’s Five Minute Read, we review a book that explains why we do the things we do – David McRaney’s You Are Not So Smart.

“Sometimes the best books about investing aren’t even about investing.”

I’m afraid I’ll have to weasel out of attributing that quote to someone as I can’t actually remember where I read it. But it’s an interesting thought that has always stuck with me. You inadvertently tend to find great insights into the world of investing in books about current affairs, futurism, the environment, etc.

This month’s Five Minute Read is one of those books that’s not actually about investing. But through it, I think readers will discover some interesting perspectives on investing.

David McRaney’s You Are Not So Smart is a collection of 48 short essays that challenge people’s basic assumptions about why they act the way they do, what they believe about themselves, and why they’re not as smart as they think we are.

About the Author

David McRaney is an American journalist and author. He is the author of the blog You Are Not So Smart, now an international best-selling book. His second book, You Are Now Less Dumb, was published in 2013.

You Are Not So Smart

As mentioned above, this book goes through 48 cognitive biases, fallacies, and psychological phenomena that affect our decision making, memory, and views of the world.

The book covers all aspects of life – from why we purchase certain things, to how we chose our friends, and even how we decide to help people in need. Each bias is explained through entertaining examples and cites scientific studies in the areas of psychology, neurology, and behavioral economics.

While many of the examples have little direct relevance to investing, in this review I’ll attempt to summarize some of those I thought would be of interest to our readers.

Confirmation Bias

The Misconception: Your opinions are the result of years of rational objective analysis.

The Truth: Your opinions are the result of years of paying attention to information that confirmed what you believed while ignoring information that challenged your preconceived notions.

This is a big one in the world of investing. Confirmation bias is a trap that we all fall into from time to time, and it comes at us in two ways.

Firstly, we can be passively biased. Imagine you are talking with your friends about an old movie that you haven’t seen in a while. A few days later, you might see that movie on TV as you are flicking through the channels. A few days later, you might be reading a newspaper and spot an article that mentions the movie.

To you, this can feel like some crazy coincidence – or worse – like the universe is trying to tell you something.

Actually, your mind is simply tricking you. Because you recently discussed the movie, its presence is fresh in your brain, and suddenly you are hyper aware of all references to it. These references were there before of course, but your brain simply ignored them.

“The real trouble begins when confirmation bias distorts your active pursuit of facts.”

People also tend to actively look for information that confirms what they already believe. The example McRaney uses is an analysis of purchasing trends on Amazon during the 2008 presidential election. Researchers found that those who bought Barack Obama’s book, The Audacity of Hope, were mostly dyed-in-the-wool Obama supporters.

They weren’t buying the book to learn any new information or to make any decisions. They simply wanted their original opinions validated. This happens in punditry all the time. Few people are going to tune into Bill Maher or Rush Limbaugh to hear opinions they don’t agree with.

But think about how dangerous this is in the world of investing. We might have an opinion on a company that we happen to like and think the stock will be a good investment. So we tend to only read the opinions of those who agree with us on that. If we come across an article in which some analyst calls it overvalued or due for a pullback, we tend to ignore it.

It’s important to recognize this bias in ourselves and be willing to listen to those who disagree with us. Being able to challenge our own beliefs is an important part of developing as an investor.

As Mark Twain said, “It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.”

The Dunning-Kruger Effect

The Misconception: You can predict how well you will do in any given situation.

The Truth: You are generally pretty bad at estimating your confidence and the difficulty of complex tasks.

In the modern world, the stupid are cocksure, while the intelligent are full of doubt” – Bertrand Russell

Have you ever wondered why people who just can’t sing are so confident when they perform on shows like America’s Got Talent? Meanwhile, the contestants who really can sing, those who’ve been training for years, seem shy and even shocked when they get put through to the next round.

This is down to the Dunning-Kruger Effect.

The Dunning-Kruger Effect is a cognitive bias in which people with little or no experience of a certain task believe they will be adept at it. On the other hand, the more someone practices or studies a task or area of expertise, the more they realize how little they know. They fully understand how complex a topic can be and how much more they have to work in order to master it.

This occurs all the time in investing. Someone buys a stock and makes some money on it. They then believe that because they made money, they must be great at investing. It never occurs to them that only one of two things were going to happen anyway – they were either going to make money or lose money.

Or perhaps someone reads a book on investing. This might be enough to make them think they’ve it all figured out. In reality, there are thousands of books on the topic, with many authors having completely contradictory views on certain aspects.

Brand Loyalty

The Misconception: You prefer the things you own over the things you don’t because you made rational choices when you bought them.

The Truth: You prefer the things you own because you rationalize your past choices to protect your sense of self.

This one was of particular interest to me since we speak so much about brand and consumer behavior in our blogs.

In it, McRaney talks about the emergence of “fanboys” – people who argue on internet message boards about how one product is superior to another. The most obvious example of this is perhaps the ongoing feud between iPhone and Samsung customers, both believing that they have the best type of smartphone.

McRaney points to an experiment at Baylor University in which people were given Coke and Pepsi in unmarked cups and hooked up to a brain scanner. The device showed that some of them preferred drinking Pepsi during the blind taste test. When those that were lifelong Coca-Cola drinkers were told this, the scanner showed that some of them actually scrambled the pleasure signals in their heads. They then lied to the experimenter, saying they had really preferred the Coke all along.

This is down to the fact that people want to associate themselves with a certain brand. If you watch advertisements for Apple products, you’ll notice they rarely talk about the spec of their latest phone or computer. What they do is show the kind of people that they want us to think use Apple products – stylish, attractive, outgoing etc. Then, when people buy them, they start believing that that’s the kind of person they are.

“You’ve been branded… and once a person is branded, that person will defend the brand by finding flaws in the alternative choice and pointing our benefits in his or her own.”

However, you’ll notice that when it comes to products that we have to own, like toilet paper or gasoline, we don’t really care about brands.

Since we can’t choose not to own these things, we really don’t care what version is better. We just know we need to have some version of it. These things also tend to be cheap. It’s the items we spend a lot of money on that get us so passionate about the choices we’ve made.

So necessity and cost play a large role in this. Stocks are something we don’t need to have and they can be quite costly. Is it any wonder then that you see online message boards of people rabidly defending their choices of stocks, sometimes with little or no empirical evidence to support why they bought it in the first place?

Should I Buy This Book?

If you’re a fan of behavioral psychology, you’ll probably find that you’re already familiar with a lot of these concepts. While reading it, I noticed plenty of the examples that McRaney gives have been widely published about before.

However, those who are new to this field will find this book to be a well thought-out and interesting beginners guide, presented in a digestible and (mostly) easy to follow format. You’ll no doubt remember times when you acted exactly how McRaney describes and feel “not so smart”.

At times, McRaney can stray into overly-technical and even boring explanations, but for the most part, his examples and anecdotes are well measured and fit the format. Other times, you’ll find the same basic theories being stretched over a number of different chapters, which can be annoying. You’ll know that you’re reading a collection of blogs rather than a complete treatise on the subject, which has both its pros and cons.

Still, it’s an enjoyable book that will make you think harder about how you make decisions and how you behave. In the world of investing, that’s always a good thing.

 

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Rubicoin operates a full disclosure policy. Rubicoin staff currently hold long positions in Apple and Amazon.

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