Man Looking

Understanding the Limitations of Our Own Faculties

Man Looking
“We're blind to our blindness. We have very little idea of how little we know. We're not designed to know how little we know.”– Daniel Kahneman The Intelligent Investor

Working in the financial services industry has been an interesting adventure. As an advisor, I act as a bridge between objective, rational, and data driven ideas and connecting them to subjective, emotional, and often irrational human beings. The value of an advisor, in my opinion, is the ability to build and maintain the strength of this bridge. Today, I would like to add another brick.

As humans, we are subject to certain behavioral biases. Finding patterns or order in the chaotic and randomly occurring events in our day serves to protect us. It allows us to anticipate potential harms and take advantage of potential opportunities. We have survived the test of time because of these biases.

At the same time we must understand the limitations of these primal faculties that have allowed us to thrive. Their double-edged nature can often force us to make misinformed decisions. Investing is probably one of the best examples.

Recently, I have been receiving questions by clients regarding prospects for the future. Some are concerned and believe that a market contraction is certainly on the horizon while other are strongly optimistic and want to “double down” on the risk in their portfolio. As Mr. Kahneman points out in his quote, a single individual has an incomplete point of reference of the world around them. This is by design.

Further, with the explosion of social media outlets we can filter the information we have access to in order to feed the narrative that we have created for ourselves. Creating a narrative is a very part of our human nature, as social and emotional beings. The current political environment is a shining example of this idea. But that doesn’t mean that this is the only narrative, right narrative, or that it is an even an accurate narrative. In fact, a single piece of factual evidence can have two different reactions by two different individuals based on their own individual narratives.

But always remember that the market is acting as an ally for you. As news and events occur, millions of market participants filter this information based on their personal narratives and embed what they believe to be the future prospects of the global markets into prices to ensure that participants are receiving a fair return for the risk taken.

As a passive investor, you benefit not only from this assurance, but you also benefit from the collective narrative about the world that is created as individual market participants come together. I often refer to this as the “collective wisdom” of the entire market. Because our own individual narratives are incomplete, the aggregate narrative created in the market reduces the risk that Mr. Kahneman astutely points out. In other words, markets help to reduce the blindness inherent in all of us.


About the Authors

Tom Allen

Tom Allen

Tom Allen is an Accredited Investment Fiduciary (AIF®), Certified Cash Balance Consultant (CBC) and a Chartered Financial Analyst (CFA®) Level III Candidate. Tom received his Bachelor of Science in Management Science as well as his Bachelor of Art in Philosophy from the University of California, San Diego.

Mark Hebner

Mark Hebner - Founder, Index Fund Advisors, Inc.  

Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors. He is a Wealth Advisor, with an MBA from the University of California at Irvine and a BS in Pharmacy from the University of New Mexico with a specialization in Nuclear Pharmacy.