Quick Thinking Leads to Bad Behaviour (Part 2)

If you have a long investment horizon, it isn’t necessary to lose sleep over market downturns.

Alex Bryan 10 January, 2019 | 8:00
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“What You See Is All There Is.” This is a phrase Kahneman frequently uses in his book to describe System 1’s tendency to focus solely on the information at hand, failing to account for relevant information that might be missing. It attempts to construct a story with that information to make sense of it and judges its validity based on the coherence of that story rather than on the quality of the supporting evidence.

For example, consider a poor-performing mutual fund that replaces its manager with a star who has a long record of success running a different portfolio at the firm. Three years later, it is among the best-performing funds in its category. That story seems to support the obvious conclusion that the new manager turned things around. But there’s not enough information to know that.

System 1 doesn’t stop to consider alternatives that weren’t presented. For instance, the performance turnaround may not have come from any changes to the portfolio. Rather, after a stretch of underperformance, the holdings the original manager selected may have been priced to deliver better returns going forward. Luck could have also played a role. However, the stories that System 1 creates leave little room for chance, often searching for causal relationships where there are none.

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About Author

Alex Bryan

Alex Bryan  is the Director of Passive Fund Research with Morningstar.

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