Nobel Prize-Winning Psychologist Daniel Kahneman on Fast Thinking in Investing

Last month, I interviewed psychologist Daniel Kahneman, who won the Nobel Prize in economics in 2002 and recently authored the book Thinking, Fast and Slow.

In this clip, Kahneman discusses how investors stricken by impulse thinking can lead themselves astray. (Transcript follows.)

Morgan Housel: So the title of your book is Thinking Fast and Slow. We're sitting in the studios of the NASDAQ, where there is a lot of information and flashing lights. The investment business in general driven by the 24-hour news cycle, almost forces investors to think fast and to act fast. How does my decision making process change when I'm in that fast thinking mode versus the calm, rational mode?

Dr. Kahneman: Again, the word "investor" here is difficult to cope with because there are so many kinds of investors, even among professionals, so if you're talking of day traders, those people who do trade over the range of minutes, and then probably a skill develops, and probably when they are skilled, they will detect patterns that may actually be there. For all I know, there may be patterns to be discovered that enable people to do well. There certainly are patterns that enable algorithms to do well in short-term trading.

I would say for individual investors, and again, when we're talking investors, let me add something else. There are different kinds of investments. Are we talking about the stock market, or are we talking about other things? Because the stock market is at one extreme where really if people think they have information and it's not insider information that they're not entitled to have, then they are probably kidding themselves in the vast majority of cases.

If there are many other markets where actually the market is not perfect and there is a lot of information that people can get and some decisions are much better than others, I would say that in general, unless you have a skill which is almost like an athlete's skill and reacting to very short-term patterns, slow thinking probably is better than fast thinking in investing.

You know this is a discipline that I think some people can impose on themselves. Let's stop and think about it, then you're in the slow-thinking mode. Let's sleep over it. You're in the slow-thinking mode. So there are many tricks that people already apply to get themselves into the slow-thinking mode. Whether they then do their homework and do it adequately and take a view of what they're doing, which is what I've called "the outside view," that is for people acting as I'm acting, what's the likely outcome? That is intelligent slow thinking, so not all slow thinking is good thinking. There's no guarantee that slow thinking is good. So some kinds of slow thinking are better than others.

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