At The Money: David Dunning professor of psychology at the University of Michigan (Go Blue!) (January 10, 2024)
Investor incompetence might play a larger role in poor performance than you think. That’s thanks to a phenomenon called the Dunning-Kruger Effect.
Full transcript below.
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About this week’s guest:
David Dunning is a professor of psychology at the University of Michigan. Dunning’s research focuses on decision-making in various settings. In work on economic games, he explores how choices commonly presumed to be economic in nature actually hinge more on psychological factors, such as social norms and emotion.
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TRANSCRIPT:
Barry Ritholtz: Everybody wants to be a great investor. We love the idea of outperforming the markets, or at the very least, beating our peers. The problem with all this foolishness is that nearly all of us lack the skill set and discipline required to create those better than average returns. Worse yet, we often fool ourselves into believing we are much more skilled than we actually are.
I’m Barry Ritholtz, and on today’s edition of At The Money, we’re going to discuss metacognition, our ability to self evaluate our own skills. to help us unpack all of this and what it means for your portfolio. Let’s bring in Professor David Dunning of the University of Michigan. He is the author of several books on the psychology of self and best known for his research known as the Dunning Kruger effect.
So welcome Professor Dunning. Let’s start with the basics. What is the Dunning Kruger effect?
David Dunning: The Dunning Kruger effect is the basic idea that people who lack expertise lack the very expertise they need to recognize the fact that they lack expertise. That is, if you don’t know, you don’t know what you don’t know.
And, so the basic problem people have is they fail to recognize their own ignorance when it comes to their skill or if it comes to, any particular decision that they may have in front of them that day.
Barry Ritholtz: So it sounds like metacognition is a separate skill from whatever fields we may be working in. It could be business, it could be finance, it could be sports. The ability to self-evaluate is its own ability?
David Dunning: Well, it certainly is its own task. That is we have to come to a decision, or at least some sort of judgment. And then there’s a second task of should we be confident in that decision, or should we have doubt? And that’s that second task. And often that’s the important one that determines whether or not we’re going to act or whether we’re going to seek advice or hedge or seek insurance.
And, it does have some skills associated with it, but often doing the second task well requires the same knowledge, the same expertise as doing the first task well. And that’s where the Dunning Kruger effect comes in. That’s the paradox, the conundrum, the issue, but it is a second task that is very, very important.
Barry Ritholtz: So, if we are not expert in a given space, it sounds like that implies we also lack the ability to judge our own lack of expertise.
David Dunning: That’s right. We have as we call it a double burden. We lack the skills to make the correct decision in the first place. That also means we don’t necessarily have the skills to be able to evaluate the decisions that we’ve made.
Barry Ritholtz: So, so this seems to be a very common problem in the field of investing with newbies or people who are early in their investment career. They have a little bit of success. Sometimes it’s luck. Maybe there’s some skill involved or some combination of both, but they develop a bit of overconfidence and that allows them to forget about “Hey, maybe I’m not an expert.” How dangerous is this out there in the world?
David Dunning: Well, it can be dangerous. And one thing to point out is that it’s a danger for everybody, no matter what your level of expertise is; As soon as you step into your own pocket of incompetence, Well, you’re vulnerable to this effect. But if you’re new to something, you’re very vulnerable to this effect. If you’re learning something, if you have a little experience, well, your experience is valuable, but you may overplay its value. You may overlearn what you’ve learned from just a little bit of experience with something. And I think you know things that actually turned out to be luck or mysteries of the situation. And that could lead you to fall prey to the Dunning Kruger effect.
Barry Ritholtz: So this sounds a little bit like overconfidence. How does Dunning Kruger effect differ from just straight up having too much belief in your own abilities?
David Dunning: Well, overconfidence is a general phenomenon, and you can find it everywhere. I would actually argue that overconfidence is inevitable. In some sense, it’s something that we’re all going to experience.
And in a sense, it’s something that we all have to manage — it’s just an inevitable fact of life. What the Dunning Kruger effect is, is just one particular ingredient, one spice that can lead people into overconfidence that is when you. are not an expert. When you’re in a situation that’s new to you, this is exactly when you’re in a situation where you may become quite overconfident.
You may think that you’ve got this when in fact you’re nowhere near having this, if you will. It’s one of the situations where overconfidence may be its most pointed or its most severe.
Barry Ritholtz: So, how should we think about our own blind spots? What can we do to make ourselves more self aware of the areas that we need some improvement in?
One of the things I keep thinking about is to resurrect that old, Apple slogan, Apple computer slogan of think different. To ask other people what they think and see if they think something different. Or do what, the professions being a lawyer or being a doctor, do. If you look at the professions, they actually institutionalize thinking different.
In the American legal system, if you’re a lawyer, you present your case. And there will be another lawyer who is going to think different from you. In fact, that lawyer is going to think the opposite of you, and it’s going to poke holes in every single argument you make. They will be thinking different.
The idea in the legal system is the truth will come out of that competition between your side and the other side. Doctors. don’t make diagnoses. They do differential diagnoses. They don’t consider what your problem, medical problem might be. They consider multiple medical problems and try to figure out what rules in this medical problem, what rules out these other medical problems.
Barry Ritholtz: So poor performers generally overestimate their skill at performance because their incompetence deprives them of the skills they need to recognize that deficit. What else should we be doing to avoid those sort of problems? You talked about speaking to other people, we talked about thinking differently. What other options do we have in our toolkit to avoid these sort of mistakes?
David Dunning: Always be learning. That is the easiest way to avoid the problems of incompetence is to become competent, although that’s very easy conceptually. I know it’s hard to do in reality, but you can always become more competent. If you will, you can always be learning.
One of the things I tell my graduate students. The way you want to feel is if you take a look at something you’ve done in the past, like some sort of research study you’ve created or something you’ve written is that you should always feel vaguely embarrassed by it, that there are things you you wish you’d done differently.
And if you feel that way, that. That’s a very good feeling, because that means you’ve grown. If you’re perfectly satisfied with it, I would be scared. That means you haven’t grown. And I myself am delighted to say I continue to embarrass myself constantly, all the time when I read myself, even in the recent past.
I’m delighted that I’m still an embarrassment. I wish it would end, but then again, I wish it wouldn’t end.
Barry Ritholtz: Huh, quite, quite, quite fascinating. So to wrap up, our inability to evaluate our own skill sets especially when we’re first starting out as investors, is a very troubling and potentially expensive human trait.
However, if we find ourselves mentors, if we’re always learning, if we look back at what we used to do — and recognize, hey, that’s a little embarrassing — it means that we’ve come a long way. As long as we can objectively measure our performance, take steps to get better. and try and stay within our own abilities, We can have much better outcomes…
I’m Barry Ritholtz. This is Bloomberg’s At The Money.
