The investment world has lost a giant with the passing of psychologist and Nobel Prize winner Daniel Kahneman.
Although Kahneman was not trained in economics, his insights into how humans make financial decisions revolutionized the field. Economists believed that people were cold, number-crunching creatures, but Kahneman showed that our emotional minds lead to biased and error-prone decision-making.
For investors, the lessons are many. Loss aversion means that the pain of losing euros is much greater than the pleasure of winning euros, and even risk-averse people may resort to risky gambling to avoid losses. (“Get out when you’re even”).
It's not a good idea to check your portfolio frequently, as losses can be emotional. As investors, we get caught up in the seductive narrative and mistake random fluctuations for meaningful trends. We tend to become overly attached to our stock holdings, even when logically we shouldn't, making us susceptible to the stock-holding effect.
Overconfidence also clouds judgment. That's why it makes sense to buy index funds instead of thinking you can predict the market.
[ Thinking straight and crooked: An Irishman’s Diary about Daniel Kahneman ]
[ To err is human: Mistakes and why we make them ]
In fact, Kahneman's work on overconfident decision-making fueled institutional skepticism about stock selection and paved the way for the explosion of cheap index funds. Kahneman changed the world. He was a great thinker and a good man and will be missed.
