Please ensure Javascript is enabled for purposes of website accessibility

Nobel Prize-Winning Psychologist Daniel Kahneman on Overconfidence in Investing

By Morgan Housel – May 6, 2013 at 3:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

"A human trait."

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 and I discuss how overconfidence affects everyone, and what role it plays in investing. (Transcript follows.)

Dr. Kahneman: Well, overconfidence is generally a human trait, optimistic overconfidence, most people are. But then when you look at investors, you are looking at the self-selected group who are likely to be more optimistic than other people. The pessimists just aren't there, so when you look at investors, you see only the optimists in the investor, the active investors who are looking for ways to get richer. So these two things together, self-selection and the general optimistic bias of mankind, I think they tell the story.

Morgan Housel: So it's more natural for us to be optimistic than pessimistic?

Dr. Kahneman: Oh yes, that's definitely true.

Morgan Housel: But at the worst times, we seem to be pessimistic as investors. In 2008, when everything's falling apart and getting cheap, the times you should be investing are when people get the most pessimistic. What is the decision-making process that people go through in that situation?

Dr. Kahneman: Well, the decision-making process is basically inferring from recent trends as if they were to continue. That seems to be the information that people go on and so when things have been getting worse for a while, you become pessimistic, and when things have been getting better for a while, you become optimistic, and it's those feelings that really control the investment, I think. It's not the reasoning that, well, things are bad, and I shouldn't invest now. That's a very unnatural frame of mind. Professionals have it, but other people don't.

Morgan Housel: So this is recency bias, when we're taking the recent past and assuming that that's going to continue in the future.

Dr. Kahneman: It's not only restricted I think to individual investors; I mean analysts also tend to predict the past to a very substantial extent. But yeah, it's extrapolation from the recent past.

Morgan Housel doesn't own shares in any of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/28/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.