Monday, August 20, 2012

A Must Read for Anyone Over Fifty

The Wisdom of Crowds
The Wisdom of Crowds (Photo credit: Wikipedia)
Daniel Kahneman
Daniel Kahneman (Photo credit: Wikipedia)

There are an increasing number of books that provide insight into how our minds work.  Emotional Intelligence by Daniel Coleman and The Wisdom of Crowds by James Surowiecki are two good examples.  Daniel Kahneman, in Thinking Fast and Slow, picks up that theme and advances it by an order of magnitude.  In my view, this is the must read book of the year, and absolutely required read for anyone over fifty.

Each knows that there are parts of our brain that toil away ceaselessly regulating breathing and blood pressure, managing digestion and keeping our heart beating on schedule without us being consciously aware of it.  From other books like Emotional Intelligence, we know that there is also a high-speed circuit that responds to stimulus far faster than conscious thinking.  There are numerous examples.  Touch something hot with your hand and you’ll move it before you actually feel the pain.  See someone you know in a busy airport or train station?  Not only will you recognize them instantly, you’ll know if they are sad or angry – our brains are hard-wired with high-speed circuits for facial recognition.

Mr. Kahneman, through a series of examples, tests, incorporation of original research and reports of research from others, informs us that our autonomous brain does far more, including a lot of things that we should be doing with our conscious thoughtful brain, but we don’t.   He uses the term System 1 for the autonomous function and System 2 for our thoughtful, conscious brain.  System 1 is fast, intuitive and emotional.  System 2 is slower, more deliberative and more logical.  Read the book and you’ll know that System 1 is doing a lot of stuff.  Most is either critical and performed well, or performed poorly but unimportant, but a certain part is done because of laziness or a concentration failure on our part, and would be much better managed by System 2.

The first few chapters are reasonably easy read and full of interesting little quizzes.  You’ll probably answer some of those quizzes wrong, and it will be because you let rapid-fire System 1 come up with the answer instead of deliberating with System 2.  One of these tests (I won’t give it away) was given to a class at Princeton, conceivably some of the best and brightest in the country, and a majority of them failed, so don’t feel too bad if you fail it also.

However, I must warn you that the content gets harder.  I’m reasonably literate in at least basic statistics, and I found myself challenged a number of times.  On more than one occasion, I didn’t understand the answer even when Kahneman gave it to me.

After proving to us that we let System 1 interfere when it shouldn’t, Kahneman provides chapters on our various thinking and logic errors and guidance on what to be on guard for to make sure we put System 2 in charge, and we prevent the vast number of thinking shortcuts that lead to suboptimal decisions. There are chapters on how a tired and overloaded brain makes bad decisions.  How we tend to be poor assessors of risk, overly concerned about low probability events and not sufficiently concerned about riskier activities.  This extends into how humans make investment decisions.  I found the chapter on “Anchoring”, that is, how we attach value to a reference number, even if we shouldn’t, particularly useful, and very valuable when approaching a negotiation.  There is thoughtful, research-based advice on when to rely on an “expert” and when not.  I am going to debate one example with Dr. Kahneman in the chapter on Regression to the Mean.  A key point of the chapter is to be thoughtful and thorough when analyzing data with significant outliers, with generally the more reliable guide is to assume a trend regressing to the mean.  I have to agree.  However, he uses an example of building a sales budget for a group of department stores, with the question of how to allocate a planned 10% total sales increase to the individual units.  It is a four unit chain, with sales history ranging from $11 million for the lowest performing store to $29 million for the best.  There is very little other information.  Kahneman’s conclusion is that more than 10% should be planned for the lowest performing units and less to the highest.  Dr. Kahneman, I totally reject that conclusion.  I’ve been an executive and an investor in a number of retail businesses.  If anything, I would allocate all of the sales increase to the better performers.  There are specific reasons why one location has sales that are more than double that of the worst performer.  It is in a better shopping center.  Or located on a street with higher traffic, or in a town with a vibrant, growing economy while the worst performer is the opposite – bad market, bad location, weak shopping center, etc.  Equally importantly, what is portrayed as four data points – e.g. annual sales, really isn’t.  Assuming these stores are opened at least six days a week, it is the result of hundreds of days of sales.  Depending upon the average item price (say five dollars, or fifty dollars or five hundred dollars) and the number of items an individual purchases at a time, this is the result of thousands or hundreds of thousands of transactions.  It is the sum of a very large number of transactions.  But to argue over one example in a very large book is clearly to quibble.

Why do I say that this is a must read for anyone over fifty?  Let’s face it.  Once we’ve crossed that line – maybe fifty for some of us, sixty or even seventy for others, we simply don’t think as fast.  Do you watch the famous game show Jeopardy?  Generally I can hold my own with many contestants.  I know a lot of the answers.  However, I also know that I can no longer come up with those answers fast enough.  The contestants buzz in way too fast for me.  There is research on the ability of us in our second fifty years to make wise investments.  It turns out that not too many of us are Warren Buffet.  We need to be cautious and thoughtful when putting our money to work.  This book provides very valuable insight into our unconsciously lazy mental habits and equally unconscious thinking errors.  It is a must-read.

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