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2. 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 and solved. The illusion of control is more
persuasive than the reality of uncertainty. So we cling to
stories about outcomes being in our control.
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