Substituting a Hard Question for an Easier One: Daniel Kahneman’s ‘Thinking Fast, Thinking Slow’

This article is written by Erik van Mechelen in “conversation” with Yu-kai Chou and Daniel Kahneman. 

Substituting for Easier Questions

Do you like Yu-kai’s glasses? You might substitute an easier question, “Do I like Yu-kai?” then quickly answer “Yes I like your glasses” and move on with your day.

In the introduction to Thinking Fast, Thinking Slow, Kahneman describes the process by which we trade hard questions for cognitively easier ones, a common behavioral and cognitive process.

On page 12, Kahneman describes a Chief Investment Officer invests tens of millions of dollars in Ford, because he goes to an automotive show, and is was impressed with the cars. “He likes the cars, he likes the company, and he likes the idea of owning its stock. From what we know about the accuracy of stock picking, it is reasonable to believe that he did not know what he was doing” because the one question should be “Is the stock currently underpriced.”

But this is where Yu-kai disagrees:

A stock could be overpriced, but due to consumer psychology, will rise even more until a correction. A fund manager could invest in the short to midterm based on investor psychology instead of accurate valuations of a stock. Also, some growth stocks are always overpriced but people are investing in where they would be in the future, as opposed to now.

The Effect of Affect Heuristic

Affect Heuristic (definition): judgments and decisions are guided directly by feelings of liking and disliking, with little deliberation or reasoning.
Yu-kai had more thoughts on this:
The issue is that other investors are motivated the same way. If you go to a car show and feel affection towards a Ford car over all the others, that means other investors are likely to do the same and buy Ford, moving the price up. As opposed to buying the worse looking unsexy car that no one cares about, the stock is cheap and undervalued, but has a grim future.
Intuitive Heuristics: when faced with a difficult question, we often answer an easier one instead, usually without noticing the substitution.” Instead of thinking if Ford is a stock worth investing in, it is substituted with “Do I like Ford cars?”

A note from me (Erik): I actually don’t mind being intellectually “lazy” in these instances (if your goal is to increase your earnings by purchasing this stock), since others will make the same “mistake”, turning your “mistake” into a good result. The difference though is knowing why you are taking an action.

When algorithms begin taking over stock market buying and selling decisions, however, humans might have a more difficult time adjusting and beating the algorithms in their deep modeling. The algorithms won’t make these sorts of mistakes.

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