Humility and Hubris
Updated: May 23, 2022
A few years ago, I attended a talk by a professional sports bettor. The aim of the talk was to explain the differencebetween professional gamblers and so-called problem gamblers. The audience was comprised of healthcare volunteers, and the distinction between the two types was important because problem gamblers were among those whom they wouldlikely be called on to support.
"The two most important powers one can possess are those of prediction and persuasion"
What struck me most about the sports bettor was his humility. He did not suggest he was special or better than others, just that he had a simple, disciplined process intended to spot the occasional mispricing of odds. If his process flagged amispricing, he would bet a percentage of his purse commensurate with the odds themselves, as well as the extent of the mispricing. Even when the potential pay-out was highest - the longer the odds and the bigger the perceived mispricing, the higher the potential pay-out - he would still only bet a relatively small percentage of his purse.
The reason? He knew he could be wrong.
Perhaps the biggest trap any professional or amateur investor can fall into is to start believing he or she is better than others. A financial market, whether stocks or bonds, is the expression of the collective intelligence of millions of individuals. Thinking by default that you are right, and the market and its millions of participants are wrong, is arrogant inthe extreme.
The problem is that arrogance serves an evolutionary purpose - to persuade others to do what you want them to do. You are much more likely to follow or be persuaded by someone who exudes confidence.
The benefits of arrogance are thus two-fold. First, the individual in possession of said quality will tend to get what he/shewants, whether a promotion or the attention of a mate. Second, society as a whole benefits by having leaders who are not afraid to act. After all, humans would not have got very far had they had nobody to lead them out of their caves.
For professional investors, therefore, whether fund managers or otherwise, success is about getting a balance between humility and hubris. You need to make good investment decisions, but you also need to persuade - perhaps the two most important powers one can possess are those of prediction and persuasion.
In his book, Thinking, Fast And Slow, Nobel Laureate Daniel Kahneman writes that: "... the optimistic bias may well be themost significant of the cognitive biases. Because optimistic bias can be both a blessing and a risk, you should be both happy and wary if you are temperamentally optimistic."
As for overconfidence among businessmen, Kahneman refers to one survey that found 81% of entrepreneurs in the US puttheir personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero. The actual probability that a small business will survive for five years is around 35%.
Kahneman does not suggest that such overconfidence is without its benefits, as it: "... encourages persistence in the face of obstacles." Furthermore, all enterprises, whether destined for success or failure, stimulate economic activity even if those in the latter category end up causing pain for one or more stakeholders.
In nature, the process of natural selection is based on successes rising above the failures. Failures are an essential component of both the living world and the business world - they provide successes with something to rise above.
Overconfidence is particularly evident in financial markets. A survey of CFOs' forecasts of S&PS00 returns found that the incidence of surprises, as defined by the CFOs themselves, was more than three times higher than they expected.
Kahneman finishes by stating that he is not optimistic that overconfidence can be overcome by training. Presumably therefore he would be even less confident in an individual's ability to exhibit both overconfidence and humility simultaneously.
This may be why genuinely skilful fund managers, like successful sports bettors, are very rare beasts indeed.
Published in What Investment
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.