Kahneman on Decision-Making, and Other Morningstar Conference Notes

Nobel laureate and psychologist Daniel Kahneman shared insights from his current research about decision-making at this year’s Morningstar Investment Conference. He described noisy interferences in the decision-making process as being more important than systematic errors.

Noise is something that interferes with the decision-making process, particularly irrelevant factors influencing a person’s judgments. Irrelevant factors can include a person’s mood, how long it has been since their last meal and the weather. The order in which information is presented creates noise; if you receive the information in a different order, you will likely reach a different decision. Noise is caused by making up your mind too quickly.

How problematic is noise? Kahneman gave an example of insurance claim adjusters. A group of adjusters were given cases to analyze. The estimates from each individual adjuster were then paired to compare the differences in judgments made between them. The company’s executives expected the differences to be within an approximate 10% range. The actual difference was 50%. This was not an isolated case as a Harvard Business Review article, co-authored Kahneman, discusses.

Using a formulaic or systematic approach limits, or at least reduces, the impact that noise has. “Algorithms are noise-free, people are not,” stated Kahneman. Another is checklists. When I asked Kahneman about checklists after his conference session had ended, he responded, “I’m a great fan of checklists. I think checklists and doing things in a disciplined way is essential. My work on noise currently is just that … it drives you to do things systematically, having a system and sticking to it.”

Kahneman is currently working on a book about noise with Harvard professor Cass Sunstein and Said Business School (University of Oxford) associate fellow Olivier Sibony. A publication date has not been set, but Kahneman thinks that based on the current deadlines, it could be available sometime in 2020.

A few conference attendees asked the psychologist during the question and answer part of his session about regret. Kahneman described regret as not being irrational, but suggested people should ask themselves, “If I do this now, how will I feel about it later?”

He then suggested splitting a portfolio into two parts (one aggressive, one less so). Kahneman thought doing may help those investors who are unable to tolerate the volatility associated with a wealth-maximizing strategy.

Though I spent much of the Morningstar conference meeting with people (and laying the groundwork for future AAII Journal articles), here are some other takeaways I have from the conference:

• Charles Schwab’s CEO Walt Bettinger says he’s not seeing downward pressure on advisory fees, but rather upward pressure on the services being offered. He does think it’s harder to beat the market today. As such, he thinks advisers should shift their client’s focus to things “under their control.”

• Morningstar’s chief behavioral scientist Stephen Wendell thinks the real challenge for retirement planning is behavioral. He is of the opinion that a combination of small changes—increasing savings over time and comparing one’s savings rates to their peers, for instance—is more effective than a “shock and awe” approach. The latter approach causes people to freeze up.

• Ariel Investments president Mellody Hobson describes the mutual fund and exchange-traded fund (ETF) giants as doing “a very good job” of selling passive investments at a low cost. At the same time, she believes the commoditization of index investing is creating inefficiencies for active investors, like her firm, to exploit.

• During a panel discussion about blockchain held for the media, Morningstar analyst Jim Sinegal noted that since we’re still in the early stages of the technology, it is very possible to be right about cryptocurrencies becoming mainstream and still be wrong about which cryptocurrency will be the eventual winner.

The Morningstar Investment Conference is an annual conference focused on mutual funds (and now ETFs). It is primarily attended by advisers, with many mutual fund, ETF and financial services companies exhibiting.