Morgan Housel on How People Think
You Know The Drill
I mentioned last week that this week we’d be looking at Morgan Housel’s “How People Think” piece. Well, you’ve had a week to read it…but I also spent 26 years teaching students. Some of you might have read it, but I’m guessing that a few of you might not have. It happens. So, go read it. You’ll find it is another excellent piece he has written. As I mentioned last week…Morgan is a GREAT writer!
Really, I’ll wait.
Okay, I’m going to assume you read it (and if you didn’t, at least nod along…just like students in class).
Item #1 — Everyone belongs to a tribe and underestimates how influential that tribe is on their thinking.
This one is especially important. If you’ve read my writing for awhile, you know it is one of my biggest concerns. How we think often creates separations, not togetherness. We can disagree without being disagreeable.
Let’s look briefly at tribalism as a concept. Essentially it is dividing people into two primary camps — “us” and “them”. The “us” is good and the “them” is not. I mentioned this before, but having gone to the University of Northern Iowa, Kansas University and teaching at Pittsburg State, I have three primary “alliances” based on schools. If someone went to one of those schools, I’m more likely to be happy when they do well (disclaimer — probably the least true for KU). John Brown or De’Vante Bausby playing in the NFL? I’m a huge fan! I actually had Devante in class and want to see them do well (or wanted to, NFL careers tend to be short). Why? Because we have something in common (even if the UNI link is gettin’ pretty old at this point).
Having things in common is good. If I tell a story about something at UNI, they are likely to recognize it and it brings us together quicker. It creates a bond easier. These are both good things as it is much easier to relate to those you share common stories with.
It is a bias that we all have. Whether it is an actor/actress, a politician, a writer (like Morgan), a singer, or any of 1001 other groups, we have people we like and dislike…and often know very little about their actual life experiences or attitudes. The tribalism vibe is stronger than most of us recognize.
We need to recognize that picking sides, just to be on a side, is rarely a good call. Instead, think hard about being on the right side (assuming there is a “right” side). There are literally WAY too many things for you to even have an opinion on. The one’s you DO have an opinion on will likely change over time as new information comes out. This actually happens rather frequently. Did you know that the human temperature is NOT 98.6? Yet, if you ask 10 people, I’m guessing most will answer 98.6 degrees. We do a poor job of updating the information we learn early on.
Try hard to drop your tribal connections and focus on making better decisions based on all the information that is available. Be flexible when someone proposes a different solution. It may not work, but listen and think about it — regardless of whether it is a “liberal” or “conservative” opinion. Instead, try hard to think about data from multiple sources. Evaluate whether they are helpful for solving the problem you are working on in either direction before forming an opinion.
Item #3 — Prediction is about probability and putting the odds of success in your favor. But observers mostly judge you in binary terms, right or wrong.
This is a point that Morgan makes by discussing the Bin Laden raid that ultimately resulted in his death.
After the Bin Laden raid, President Obama later said the odds placed on whether Bin Laden was actually in the target house were 50/50. A few years ago I heard one of the SEALS involved in the mission speak at a conference. He said, regardless of whether Bin Laden was in the house, the team felt the odds they’d all be killed in the mission were also 50/50. So here we have a 75% chance that the raid would have ended in disappointment or catastrophe.
So, a 25% chance that the mission would lead to success. You can easily argue the percentages. Maybe it was 60/40 (or even 75/25) that Bin Laden was there. Maybe it was a 75/25 probability that we’d succeed. That still puts the odds of success at .75^2 = 0.5625. Barely over a 50% chance of success, even with shifting the odds dramatically up in both instances.
If he wouldn’t have been there, it probably would have barely been mentioned in the news and we wouldn’t have known. If he would’ve been there and the US team destroyed, it would have been far worse. Nine out of sixteen times we “win” and seven out of sixteen times we “lose”… even WITH dramatically increasing our probability of success in both cases. However, the other two alternatives (he wasn’t there or he was there and the US lost lives without success) quickly disappeared from the narrative. We don’t remember what doesn’t happen!
We are also terrible about getting the probability right. Consider the following data from “If You Say Something Is ‘Likely,’ How Likely Do People Think It Is?”
Not only is the word itself subject to debate, so to is the interpretation by men vs. women (with women taking the language a bit more seriously). Women are also likely to use more uncertain terms than men when describing situations. We (both men and women) also tend to be overconfident.
For example, in another survey we asked respondents to answer 50 true or false questions (for example, “The earth’s distance from the sun is constant throughout the year”) and to estimate their confidence. More than 11,000 people participated. The results show that the average confidence in answering correctly was 70%, while the average number of questions answered correctly was just 60%.
So, are you assigning something a 50% probability when it should be a 62% probability? Keep in mind, we aren’t even talking about the outcome yet…just the probability of it happening. Now factor in the outcome. How important was it to capture/kill Osama Bin Laden? What was the value of the SEAL Team sent in to carry out the mission? It is hard to evaluate the decision without those pieces of information. Yet, they aren’t related (at least directly) to the probability of success.
One way to improve your decision process is to try to be as precise as possible in your forecasting. Instead of saying “I think Kansas City is going to win the 2023 Super Bowl” you might try saying “I think that there is a 0.33 probability of Kansas City winning the 2023 Super Bowl.” Then, keep track of your successes/failures over time. You can even update the probability of Kansas City winning the 2023 Super Bowl in real time throughout the season. Did it dip when they traded away Tyreek Hill? Will it go up if they win their first 3 games? Note that none of these are one-off predictions. You need to do it for as many things as possible. Keep track of your results AND assess your performance. Are you overly optimistic/pessimistic? If the former, make a point to lower your probabilities (or increase them if the latter). Do you find you are both? If so, think about what is driving the predictions. However, you can’t do any of this without first trying to think in terms of probability.
Or, if you want more credit for your “winning” calls, there is another solution. No one is going to care about your track record. Make a big call and get it right (even if you’ve messed up many times before) and you’ll be a genius. The key is to predict things with a low probability of success. That way, you are bound to occassionally “win”! Please note that my advice here is only partially serious…however, don’t dismiss the partially!
Item #9 — We are swayed by complexity when simplicity is the real mark of intelligence and understanding.
This is probably my greatest strength (which you are likely doubting tremendously as you read the long diatribes I write). Making the complex simple. When I was taking a PhD statistics course, I was accused of copying from people who I helped explain the answer. The instructor (or more likely the grad student grading the homework) looked at my solution as too simplistic because I was leaving out the steps that seemed irrelevant to me. The assumption was that I was just copying their work.
Even though it was 30 years ago, this is something I still remember because some things are quite simple for most of us. It is our superpower. For me, it is finance and understanding decisions (more so understanding the decision than actually making one). For others, it may be playing football, artistic activities, mathematics, writing, or many other possibilities. However, PLEASE don’t ask me to draw anything, speak a foreign language, play an instrument or many other common tasks. I will look like a 3-year-old. I drew a stick figure of our daughter as part of our adoption homework because (a) I didn’t care what she was going to “look” like and (b) I can’t draw a person to save my life…literally.
One thing to remember in the simple vs. complex debate is NOT to make things so simple that you’ve removed ALL of the nuance and complexity. Instead, at each instance, think “Does it NEED the complexity to be understood and applied?” If so, you’re going to need to include it. However, if not LEAVE IT OUT. You are only going to make things more confusing. So why do we see such complexity? Here’s Morgan’s view
But computer scientist Edsger Dijkstra once wrote:
Simplicity is the hallmark of truth— we should know better, but complexity continues to have a morbid attraction. When you give for an academic audience a lecture that is crystal clear from alpha to omega, your audience feels cheated and leaves the lecture hall commenting to each other: “That was rather trivial, wasn’t it? The sore truth is that complexity sells better.
The sore truth is that complexity sells better.
and
One is that length is often the only thing signaling effort and thoughtfulness.
A second is that things you don’t understand create a mystique around people who do.
A third is that complexity gives a comforting impression of control, while simplicity is hard to distinguish from cluelessness.
Thus, complexity is important because it (a) provides a signal to how much effort YOU put in to understand the concept, (b) makes you appear smarter (he must be really smart to understand such a complex process) and (c ) gives you the illusion of control. In other words, complexity sells because it makes you seem smarter…even when that is not the case. Keep things simple (but not simple to the point you lose the concept) because it IS smarter, not because it makes you seem smarter.
Item #4 — The gap between knowing what to do and actually getting people to do it can be enormous.
Here is Morgan on the topic:
I once asked a doctor: What’s the hardest part of your job?
It wasn’t the stress or responsibility. It was so basic. “Getting my patients to do what I ask of them,” she said.
I didn’t understand at first, but it made sense when she explained.
“You have an appointment with a patient and you say, ‘I need you to get this lab done, see this specialist, pick up this medicine.’ And they come back a month later and they haven’t done any of it.” They either couldn’t afford it, or it was too intimidating, or they didn’t have time.
She explained that becoming a better doctor meant spending more time managing her patients rather than managing those patients’ illnesses. There is a huge difference, she said, between an expert in medicine and an expert in healthcare.
Having spent the last 3.5 months in the health care system, this really hit home with me. I had the conversation with my wife about what percentage of people actually DO what their doctor asks (take pills appropriately, schedule appointments, get lab work done, etc.). We assume it is everyone. It isn’t. It probably isn’t even 50% of people doing what they are supposed to be doing. That assumes that the doctor is ALWAYS correct which is another huge assumption…if in doubt, watch Dopesick (and yes, I’m aware it is a fictional telling of the OxyContin crisis, but still reasonably accurate).
Morgan expands on this with the following on hacks (shortcuts to success)
In many cases this is caused by the appeal of hacks – shortcuts and tricks to get what you want without paying the price. The patient doesn’t want to eat better and exercise; they want a pill to fix everything. The investor doesn’t want to wait a decade for their money to compound; they want a stock that will double next week.
Know anybody that invested in crypto, Peloton, AMC/GameStop, SPACs, etc? How much do they try to understand things like discounted cash flow analysis, unit economics, or the relationship between return on invested capital vs. weighted average cost of capital? Or did they find a compelling story about how Elon Musk is promising to introduce robots and assume that it is a compelling case? Note that it MAY BE a compelling case. However, it is the case for initiating research into the investment, not a buy/sell decision.
Finance really is super simple. You don’t need an advanced degree or a high powered brain (damnit, I need to stop giving away the secrets!). Instead, the solution is pretty basic:
Save money on a regular basis. The earlier the better. Assume you make $40,000 a year and save 9% of your income (get a 50% match and this is 6% out of pocket), earn an 8% average return and get a 3% raise each year. After 1 year, you have $3734.98, but $3600 of that is your savings and only $134.98 is investment income. After 10 years, you have $61,713.95, but again $41,269.97 is your savings and only $20,443.99 is investment income. However, in month 118, you actually earned more than you saved! In month 360, you saved $706.97, but actually earned $3966.23 in investment income. In the last 10 years, you save a total of just under $100,000 ($99,444.86), but earn $776,931.76! You are now earning almost 8 times what you are saving. Here is the spreadsheet if you want to play around (it seems to work well, but I didn’t really check it closely).
Diversify your investments. Don’t just hold stocks. Hold stocks, bonds, real estate, gold. Check out ValueStockGeek’s Weird Portfolio. Is it a perfect portfolio? Nope. Does it do a great job of reducing risk and creating a reasonable portfolio? Absolutely. Whatever mix you decide, evaluate it annually to adjust to your risk tolerance (it’s probably lower than you’d think).
Minimize investment leaks. Keep expense ratios (or management fees) as low as possible, avoid taxes to a large extent (rarely trade) through tax-sheltered investments (Roth IRAs, 401k Programs, etc.), etc. You’ll be able to keep more of the money you earn rather than use it to pay taxes and managers.
Insure that which you can not afford to lose. Life insurance if you have a family depending on your income (term life and let it expire in your 50’s), property (such as house, car, etc) and such.
Four simple steps will put you on the fast track to being financially successful. Is there more to it than that? Sure there is (can’t give ALL the secrets out), but this is the simple vs. complex answer. Do these four things consistently (easier said than done) and you will find your financial life much healthier. It’s just not a hack. Instead, it is a simple, but long-term, solution that actually works.
What Else?
Okay, assuming I have my normal 150-200 people reading this (assuming the substack updates are reliable…always a bit tricky). What things stood out to YOU? I don’t want to cover all 17 items (this is long enough with 4), but there had to be something you found intriguing. What was it? Why was it? Leave some feedback!