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 why we have a natural tendency to assume the future will look like the recent past. (Transcript follows.)
Morgan Housel: When the evidence is so clear that the recent past is probably not going to predict the future, why is the tendency so strong to keep assuming that it will?
Dr. Kahneman: Well, people are inferring a sort of causal model from what they see, so when they see a certain pattern, they feel there is a force that is causing that pattern to, that pattern of behavior and behavior in the market and to continue. And then if the force is there, you see the extending. This is really a very, very natural way to think. When you see a movement in one direction, you are extrapolating that movement. You are anticipating where things will go and you are anticipating usually in a fairly linear fashion, and this is the way that people think about the future generally.
Morgan Housel: So we're looking for patterns?
Dr. Kahneman: We are looking for patterns, we find patterns, and we look for simple patterns. We don't look for cycles. That is, we're naturally wired, I think, really to look for extrapolations. Looking for cycles is a professional thing. It's much more complex.
Morgan Housel: And that extends far outside of investing, the search for patterns, right? That's a pretty natural reaction.
Dr. Kahneman: That is absolutely basic to the way the mind works. The mind is an instrument for interpreting the world, and so it seeks to impose patterns on experience.
Morgan Housel: Are we good at finding patterns, or do we find a lot of spurious patterns that we think are patterns, but they aren't?
Dr. Kahneman: We are biased toward finding patterns and we are biased toward finding simple patterns, and so we tend to create patterns from too little information. We tend to create patterns from unreliable information, but that provides some kind of interpretation of whatever information there is. We are not wired to wait for a lot of information before making up our mind; that's not the way the system works. The system makes up its mind as it goes and generates the best interpretation possible as it goes. That seems to be the way we're set to work.