We Are Less Than Rational

Investment Belief #3: We aren’t nearly as rational as we assume

Traditional economic theory insists that we humans are rational actors making rational decisions amidst uncertainty in order to maximize our marginal utility. Sometimes we even try to believe it.  But we aren’t nearly as rational as we tend to assume. We frequently delude ourselves and are readily manipulated – a fact that the advertising industry is eager to exploit.¹

Watch Mad Men‘s Don Draper (Jon Hamm) use the emotional power of words to sell a couple of Kodak executives on himself and his firm while turning what they perceive to be a technological achievement (the “wheel”) into something much richer and more compelling – the “carousel.”

Those Kodak guys will hire Draper, of course, but their decision-making will hardly be rational. Homo economicus is thus a myth. But, of course, we already knew that. Even young and inexperienced investors can recognize that after just a brief exposure to the real world markets. The “rational man” is as non-existent as the Loch Ness Monster, Bigfoot and (perhaps) moderate Republicans.  Yet the idea that we’re essentially rational creatures is a very seductive myth, especially as and when we relate the concept to ourselves (few lose money preying on another’s ego). We love to think that we’re rational actors carefully examining and weighing the available evidence in order to reach the best possible conclusions.

Oh that it were so. If we aren’t really careful, we will remain deluded that we see things as they really are. The truth is that we see things the way we really are. I frequently note that investing successfully is very difficult. And so it is. But the reasons why that is so go well beyond the technical aspects of investing. Sometimes it is retaining honesty, lucidity and simplicity – seeing what is really there – that is what’s so hard.

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Mad Men Returns

The great show Mad Men returns for its penultimate season Sunday evening.  As the terrific critic Andy Greenwald emphasizes, “It’s not plot that makes Mad Men the best series on television; it’s depth.” Here’s another snippet:

The show is still, more than ever, about just who Don Draper really is. But it turns out the soap-operatic secret our dapper hero had been hiding was nothing but a Band-Aid pasted over a far deeper wound. Identity and purpose are much more elusive than a set of dog tags or a bespoke suit. They can’t be bought with a big salary nor conquered with charm. And, despite Don’s desperate searching, they’re equally unlikely to be discovered lurking at the bottom of an old-fashioned or in the bedroom of an alluring stranger.

You can get ready by watching the following from last season’s first episode.

The Narrative Opportunity

Regular readers of this site know that I reference and write about what Nassim Taleb calls the narrative fallacy often.  It is our tendency to look backward and create a pattern to fit events and to construct a story that explains what happened along with what caused it to happen.  We all like to think that our decision-making is a rationally based process — that we examine the evidence and only after careful evaluation come to a reasoned conclusion as to what the evidence suggests or shows.

But we don’t.