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Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.
My daughter is about a year old as I write this. She’s curious about everything and learns so fast.
But sometimes I think about all the stuff she can’t comprehend.
She has no idea why her dad goes to work every morning.
The concept of bills, budgets, careers, promotions, and saving for retirement are completely foreign to her.
Imagine trying to explain the Federal Reserve, credit derivatives, or NAFTA to her. Impossible.
But her world isn’t dark. She does not wander around in confusion.
Even at a year old, she’s written her own internal narrative of how everything works. Blankets keep you warm, mom snuggles keep you safe, and dates taste good.
Everything she comes across fits into one of a few dozen mental models she’s learned. When I go to work she doesn’t stop in confusion, wondering what salary and bills are. She has a crystal clear explanation of the situation: Dad isn’t playing with me, and I wanted him to play with me, so I’m sad.
Even though she knows little, she doesn’t realize it, because she tells herself a coherent story about what’s going on based on the little she does know.
All of us, no matter our age, do the same thing.
Just like my daughter, I don’t know what I don’t know. So I am just as susceptible to explaining the world through the limited set of mental models I have at my disposal.
Like her, I look for the most understandable causes in everything I come across. And, like her, I’m wrong about a lot of them, because I know a lot less about how the world works than I think I do.
This is true for the most fact-based of subjects.
Take history. It’s just the recounting of stuff that already happened. It should be clear and objective. But as B. H. Liddell Hart writes in the book Why Don’t We Learn From History?:
[History] cannot be interpreted without the aid of imagination and intuition. The sheer quantity of evidence is so overwhelming that selection is inevitable. Where there is selection there is art. Those who read history tend to look for what proves them right and confirms their personal opinions. They defend loyalties. They read with a purpose to affirm or to attack. They resist inconvenient truth since everyone wants to be on the side of the angels. Just as we start wars to end all wars.
Daniel Kahneman once told me about the stories people tell themselves to make sense of the past. He said:
Hindsight, the ability to explain the past, gives us the illusion that the world is understandable. It gives us the illusion that the world makes sense, even when it doesn’t make sense. That’s a big deal in producing mistakes in many fields.
Most people, when confronted with something they don’t understand, do not realize they don’t understand it because they’re able to come up with an explanation that makes sense based on their own unique perspective and experiences in the world, however limited those experiences are. We all want the complicated world we live in to make sense. So we tell ourselves stories to fill in the gaps of what are effectively blind spots.
What these stories do to us financially can be both fascinating and terrifying.
When I’m blind to parts of how the world works I might completely misunderstand why the stock market is behaving like it is, in a way that gives me too much confidence in my ability to know what it might do next. Part of the reason forecasting the stock market and the economy is so hard is because you are the only person in the world who thinks the world operates the way you do. When you make decisions for reasons that I can’t even comprehend, I might follow you blindly into a decision that’s right for you and disastrous to me. This, as we saw in chapter 16, is how bubbles form.
Coming to terms with how much you don’t know means coming to terms with how much of what happens in the world is out of your control. And that can be hard to accept.
Think about market forecasts. We’re very, very bad at them. I once calculated that if you just assume that the market goes up every year by its historic average, your accuracy is better than if you follow the average annual forecasts of the top 20 market strategists from large Wall Street banks. Our ability to predict recessions isn’t much better. And since big events come out of nowhere, forecasts may do more harm than good, giving the illusion of predictability in a world where unforeseen events control most outcomes. Carl Richards writes: “Risk is what’s left over when you think you’ve thought of everything.”
People know this. I have not met an investor who genuinely thinks market forecasts as a whole are accurate or useful. But there’s still tremendous demand for forecasts, in both the media and from financial advisors.
Why?
Psychologist Philip Tetlock once wrote: “We need to believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.”
Satisfying that need is a great way to put it. Wanting to believe we are in control is an emotional itch that needs to be scratched, rather than an analytical problem to be calculated
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