The investing world has lost a giant with the passing of psychologist and Nobel laureate Daniel Kahneman.
Kahneman had no training in economics, but his insights into how humans make financial decisions revolutionised the field. Economists used to believe people were cool-headed number crunchers, but Kahneman showed our emotional minds drive biased and error-prone decisions.
For investors, the lessons are many. Loss aversion means the pain of a euro lost is much greater than the joy of a euro gained, and even risk-averse people can resort to risky gambles in an effort to avoid a loss (“I’ll get out when I’m even”).
Losses make us emotional, that’s why it’s a bad idea to check your portfolio too often. As investors, we get caught up in captivating narratives, mistaking random fluctuations for meaningful trends. We are prone to the endowment effect, becoming overly attached to stocks we own, even when logic suggests we shouldn’t.
Overconfidence, too, clouds judgment, which is why it makes sense to buy index funds instead of assuming we can predict the market.
[ Thinking straight and crooked: An Irishman's Diary about Daniel KahnemanOpens in new window ]
[ To err is human: Mistakes and why we make themOpens in new window ]
Indeed, Kahneman’s research regarding overconfident decision-making fuelled institutional doubts about stock-picking, paving the way for the explosion of cheap index funds. Kahneman changed the world. A brilliant thinker and a good man, he will be missed.
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