Monday, March 18, 2013

Book Review (#1 of 2013) Thinking Fast and Slow by Daniel Kahneman

Kahneman is a Nobel laureate whose work I was already familiar with, particularly after having read the book Nudge (my review). Thinking Fast and Slow (TFAS) explains the nuts and bolts behind behavioral economics, and how, as psychologists, Kahneman and Amos Tversky helped shatter certain foundations of microeconomics-- namely utility theory and the way economists assume rationality and preferences work among people making choices.

Since studying economics, I've striven to be "rational," to think like an "Econ" as opposed to a rational human. (By "rational" I mean the definition of "having internally consistent beliefs.")
This book helped illustrate how impossible that is, even for the most self-aware. The helped me think about my own cognitive biases and the emotions behind some of my decision-making.

Every chapter is similar, which makes it rather monotonous. A hypothesis springing from a real-life observation, an explanation of various (often amusing) experiments done, some conclusions, and then a "how to apply this discovery or concept to everyday conversation/decision making."

The book starts by differentiating our thinking into two "systems," which become our friends throughout the book. System 1 is the instinct, gut reaction system. System 2 is the slower, processing system. If I write "2 + 2," your System 1 immediately says "4." But if I say "2 x (3 x 5) / (4 x 44)" you have an instant physiological reaction-- your pupils dilate, your heart rate increases, and your System 2 goes to work figuring it out.  Kahneman points out many illogical errors our System 1 is prone to make, and how to address them. This is a crucial concept for leaders and decision-makers.

For example, System 1 often falls for the "halo effect," assigning multiple positive attributes to someone just because we like one particular attribute of them. You see someone giving a speech with a warm smile-- perhaps it subliminally reminds you of your uncle. You feel he must be a nice guy, an honest guy, a good family man-- someone you can trust. But all you know about him is his smile. Choosing to vote for him on your assumptions is illogical. But, politicians through the ages have gotten elected on little more than their physical attributes.
This is one reason I don't watch political speeches and debates often-- I prefer to read them afterwards. This helps eliminate the halo effect from the person's body language, looks, smile, audience reaction, etc.

System 2 is "lazy," according to Kahneman-- it requires focused effort. Perhaps the above helps explain why "Stocks with pronounceable trading symbols (like KAR or LUNMOO) outperform those with tongue-twisting tickers like PXG." Our System 1 likes simple things. (Kahneman says that finance is "an entire industry built on the illusion of skill," eagerly reminding us that return of index funds beat returns of actively-managed portfolios.)
System 1 also falls for the fallacy that human intuition is better than algorithms based on statistical data. This is the old Money Ball debate. Algorithms beat humans, get over it. System 1 is too optimistic. Optimism seems hardwired into the human psyche and helps explain our capitalist system as well as Westward expansion. Entrepreneurs rate their chances of success much higher than historical odds. If they were relying purely on their System 2 to make the decision to enter the market, they might never enter as rational justification falls away quickly.

Kahneman won the Nobel for prospect theory, which he explains in detail. Two identical propositions presented differently lead to different preferences from the responder, something that shouldn't happen if people are rational calculators, as standard economics assumes. People are loss-averse, proven time and again in experiments. If I offer you $50 for certain or a 75% chance to win $100, you should logically take the chance (your expected payout is $75 compared to the $50)-- but most people don't, they'd rather take the sure thing. The pain of losing the sure thing would outweigh the potential gain. This loss aversion shows up in various aspects of life. Studies have found that golfers putt better when going for par than they do for birdie-- they don't want to bogey.
"If in his best years Tiger Woods had managed to putt as well for birdies as he did for par, his average tournament score would have improved by one stroke and his earnings by almost $1 million per season."

It seems obvious to me that Kahneman doesn't have any kids, as he makes observations that any parent would see as obvious. Most of his experiments involved adults, and it would have been interesting to see how kids behave in similar situations.

There are too many examples of cognitive biases and fallacies to list here, but one section that was new to me was the idea of there being an "experiencing self," and a "remembering self."
"What we learn from the past is to maximize the qualities of our future memories, not necessarily of our future experience. This is the tyranny of the remembering self."
You often don't remember the wonderful game your NCAA basketball team played, or the fact that the best player went 10-12 from the field, an excellent percentage. What you remember is that he missed the shot at the buzzer that would have given your team a win-- a memory that still stings. You disregard the 24 other shots your team missed from the field that would have also made the difference-- that last memory is what "lost the game." 

People's evaluation of overall well-being is dependent upon recent events and what stands out in memory.  A fascinating experiment revealed:

"Adding 5 'slightly happy' years to a very happy life caused a substantial drop in evaluations of the total happiness of that life."
People would rather go out "on top" than see a significant decline in performance, happiness, or health before going out.  It's a tragedy when an athlete plays too long as a diminished version of his former self-- he's ruined the memories of so many, and diminished his previous accomplishments. This is logically nonsense, his previous records haven't changed, only our current evaluation of him. 

How the "remembering self" handles regret was particularly important to me. When making a major decision, factor in what the reduction in your happiness will be if it doesn't work out the way you hope. Add that to the cost/benefit analysis of making the decision.

It's not all gloom and doom, Kahneman tells us what research says about "happiness," which is tricky to define. Income above $75,000 in the U.S. has rapidly diminishing marginal returns to happiness. More education, likewise, correlates with more stress and less happiness. 

"Religious participation also has relatively greater favorable impact on both positive affect and stress reduction than on life evaluation...Surprisingly, however, religion provides no reduction of feelings of depression or worry."

Marriage, in itself, is an overall wash because it improves some areas of satisfaction while worsening others. Kids bring satisfaction, but only if the time spent with them isn't a chore-- driving them all over town to their many activities, for example, can be much more stressful than satisfying.

Research has shown Kahneman:
"It is only a slight exaggeration to say that happiness is the experience of spending time with people you love and who love you."
Kahneman recommends switching from passive leisure, like watching TV, to more "active leisure," like socializing with friends, exercising, and doing other non-obligatory activities with people you enjoy being around.

I give this book 4.5 stars out of 5. A very worthwhile read.

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