Preston Pysh  07:51

I am worried.

Stig Brodersen  07:53

We are all worried but also please remember that Preston and I are huge economic geeks. I’m sorry that I’m dragging you down here with me. But we really love this stuff. And we really, really geek out on this and studying this even more. And this is just a lot of fun for us as well, as it’s just very interesting and concerning.

But if you are investing for the long run, if you are buying a business at a great price, and you know that these products will be bought and consumed by the population decades from now, don’t be too concerned. Don’t pay too much attention to this. There are some fundamental things but a lot of is nice, too.

Preston Pysh  08:29

I love that point. I absolutely love that point because you know who’s out there buying right now? It is Warren Buffett. He’s out there buying and I mean, there’s no disputing that. I want to say in the last month, he’s conducted at least $36 billion worth of acquisitions. He completely ignores the macro piece of this. He completely ignores it. Now, there are

Other billionaires out there. All they do is the macro piece of it and that’s how they’ve made their money like Ray Dalio. You know, you can do this Buffet approach. You can say, “You know what? It might go down 50%, the market might go down 50%. But if I’m holding a great business, and I’m holding it for the long haul, and it’s paying me a dividend, in the end, it’s not really going to much matter if I continue to invest my cash flow month over month.” And that is definitely an approach that we recommend. It is an approach that obviously worked very well for Warren Buffett and many other value investors.

We definitely still recommend the Warren Buffett approach to invest but at the same time, we are cautioning folks, we think the market is at a high level. We think that there’s going to be a downturn. Does that mean that you should stop investing completely? Absolutely not. You’ve got to invest based on your personality and which approach empathizes with your personality the most.

Stig Brodersen  09:47

In a month, you’ll have a chance to listen to two episodes from now, we will actually go in-depth with Warren Buffett’s two last purchases.

Preston Pysh  09:56

Something else that would be an interesting discussion. I think Hari is at Mohnish Pabrai’s shareholder meeting. I think maybe this weekend or it’s right around now. So I think Hari is going to have gone to that shareholder meeting. And he can discuss that as well to see what Mohnish Pabrai is talking about these days. So it should be an interesting discussion here and two episodes from now.

Let’s go ahead and hop on over to the book. The name of the book is “Thinking, Fast and Slow.” And this is by Daniel Kahneman. And this book was recommended by Wesley Gray. And I think if you go back and you listen to the interview with Wes, particularly the second part interview with Wes, he had some amazing conversations about this psychology piece and basically breaking apart the quality of a business and basically the value piece or the price of the business, and talking about how the price is absolutely controlled by psychological factors, whereas quality is not. And I think that that was a fantastic part of that interview. I really enjoyed the points that he made, and I think that a lot of those points stemmed from this type of book, “Thinking, Fast and Slow” that Daniel Kahneman talks about.

So this book was very long. A lot of chapters in this book, I thought that there were some fantastic points in this book. But at the same time, I thought that it was total overkill, and it was way too long for the amount of information that was in it. I would recommend the book “Influence” ten times over this book, just because I liked the format of “Influence” a lot better. And I thought that it was just a lot easier to read. Like this got really technical and he would just drone on about the same point for I mean, pages and pages. That was a part of the book I didn’t really care for. And to be honest with you, I don’t even know if I would recommend it just because for me, it was really long and it took up a lot of my time.

Stig Brodersen  11:44

I was almost not going to take this book. Now., I want to first I want to tell you the reason why. I have always been a big fan of Kahneman and he’s someone I’ve been following for a time so I was just all over it, when I heard that he was pumping some new book. So that was actually the reason why. But I saw that this book was over 20 hours, I mention all the book-length in hours. But what would you say, Preston, 20 hours of that book, it’s like 700 pages or 800 pages?

Preston Pysh  12:12

It’s a big book. I guess we look at it from a time standpoint because our time is so limited to get through things. And that’s where I got a little frustrated with the book is because it was just, it just went on and on.

Other than that, and I think it’s important for people to understand the context here. So, Daniel Kahneman, he’s a Nobel Prize winner in economics, I mean, extremely gifted with the content that he’s talking about. And the proof that he provides the back it up is unprecedented. So I don’t want to take away from that. I just want to prepare people that if you would read this, it’s going to take a long time, and it’s a little repetitive. So just be aware of that.

12:48

So let’s go ahead and hop into the discussion of the actual points in the book, which we’re going to summarize for you here. This book for me was important in the fact that I am a very intuitive person. Whenever I took a personality test, I think Stig and I were talking about the personality test that we took maybe six months ago or something. One of the strongest characteristics of my personality is that I’m very intuitive.

And this book shattered a lot of that intuition that I have because he talks about in the book, he starts off talking about two systems. And he calls it the fast thinking and slow thinking. And what he really breaks this down to is that your intuition and your sensing capability is that fast thinking, the thinking that happens immediately. So as you’re in a situation, you meet somebody for the first time, you’re fast thinking: you will develop an opinion of that person immediately. You can’t even control it. It just immediately happens, no matter how hard you try that occurs.

13:51

But what he says in the book, he provides substantial evidence for is that a lot of the times your fast thinking puts you in a position where you are being set up for failure because you don’t do any type of analysis behind that fast thinking. And you just immediately react to it. And it’s interesting because this really does go back to the Cialdini book where he was talking about influence, where your mind develops these shortcuts.

I saw a lot of parallels in that book “Influence” and this book “Thinking, Fast and Slow,” where your mind has developed these shortcuts. And because you’re not exercising that slow thinking and really doing the legwork and the muscle work behind trying to validate whether something’s true or false. People typically just take that shortcut and they use their lazy, immediate intuition to just go with whatever they feel like is because they already know the answer. And I think that that’s a very powerful idea.

Stig Brodersen  14:45

I think the neat thing about the way Kahneman is writing is that he has a fun fact funny story for each of his points. One of them I found really frustrating and concerning, but also very interesting was that he talks about how System One makes as many mistakes. And he’s saying that the more deprived we are, the more tired we are. If we are hungry, we tend to think more with system one and system two. And clearly, that makes a lot of sense because if you’re thinking with system two, you have to use a lot of energy. And if there’s one thing you don’t have, if you don’t have enough sleep, if you’re hungry, well, clearly, that’s energy.

He was saying that he or he was it his colleagues, they were looking at judges and the way they were looking at paroles in Israel. And he was saying that or all they would give parole to 35% of the applicants. Now, what he was also saying is that right after the dinner break, that rate was 65%. And right before the dinner break, it was close to zero. What does that mean? Now what he’s saying is that the standard way of thinking if you’re a judge, that is not to grant the parole So he was saying that because people are having *inaudible when they come back for a dinner break, that was probably why they were more willing to grant those paroles. I found that frustrating, again, concerning. Is that really how the system works?

Preston Pysh  16:09

Yeah, I think that it’s absolutely true. And we’ll give more examples later on because he gets into a thing called anchoring, which I think is a really important idea to understand. But going back to this system one and system two, this fast thinking and slow thinking. So that’s an idea I think that it’s really important, that your system one is trying to always make something normal and normalize the information.

Where you have to always tap into your system two, which is your slow thinking, in order to validate is this really normal. So using maybe a stock market example, when we see the stock market go down by 1000 points in one day, your system one is saying, “Yeah, well, the stock market goes up and down. That’s normal information. ” Then when you go into your system two, and you’re saying, “Okay, well, let’s do some hard math and some hard understanding. How many times as the stock market went down 1000 points in one day? Okay, well, it’s only happened three or four times. I don’t know what the actual numbers, but I would argue it’s probably you can count it on your hand.”

And so now it doesn’t seem like it’s so normal of a circumstance. What caused that to happen? And that’s where you really got to have an understanding of what’s happening between your fast and your slow thinking, how there might be implications for that.

17:21

While we’re on this subject, and we’re going to veer off of the book for just a second, because this is a really important discussion, and I wanted to talk about this in the first part that we did not. So on that day where the stock market was down 1000 points. I think this happened what two or three weeks ago, Stig, where we had the market on a Monday morning, it went down 1000 points at the open. That is totally nuts. And that’s crazy.

But I think the deeper discussion here is this ETF point of view that Carl Icahn had brought up, what was it a month before this happened? Everyone out there was saying, “Carl Icahn is crazy. That guy doesn’t know what he’s talking about. He doesn’t understand how ETFs work.”

Well, in fact, Carl Icahn did understand how ETFs work because one of the most amazing parts of this swing, this thousand point swing, on that day was the fact that some ETFs lost track of their fundamental and their underlying assets by more than 20%. There were some ETFs that were down 26% that morning at the open, and the fundamental assets that they actually represented were only down 6%. This is a major concern. And this is something that we should have talked about at the start of the show. So I’m glad that we’re bringing up right now because this is something that I think people really need to understand is that there’s a potential bottleneck when there’s an enormous amount of volume of trade in an ETF. And this is something that I think a lot of people did not understand. There’s only one person that brought this up and it was Carl Icahn, and he was absolutely right. And I am very, very impressed with his ability to see this ahead of it happening and to talk about it and to really stick his neck out there.

19:03

And so just so people understand what’s happening here, you have an ETF that tracks underlying assets. But whenever you put in a market order, okay, there might be an enormous amount of people sitting in that ETF veil, that maybe want to get out of that position. Well, if that happens, when the market is closed, particularly when the market is closed, and you’re putting in market orders to sell, those might get exercised at a very quick pace. And this deviation, this 20% deviation occurred in a very short window of time. You know, it really corrected itself on the same day.

But I think the learning point here for folks is, I would tell you don’t be scared of an ETF and that happening to you. What you need to be scared of is if the market is closed, and you put in a market order to exercise the following morning at whatever the market price is. You could potentially set yourself up for a very devastating event.

So the point is this, I would recommend selecting that position while the market is open. If you do absolutely want to do a market order, which  I don’t know why anyone would really want to do that. But if you do want to put in a market order, I think you need to make sure that the market is open because the chances of a disparity of millions of people all trying to conduct that trade in the millisecond that you put the order on while the market is open is pretty much non-existent. I don’t think that there’s a risk there.

But if you put it on after hours, I think there’s a concern and I think this is a really important thing for people to understand if you’re an ETF buyer or seller. If you’re holding the ETF for the long term, it won’t ever matter. But if you’re trying to conduct a buy or sell, this is something that you absolutely need to think about and fully understand, if you ever get involved in it.

All right, so let’s go ahead and continue on with the book. So we’ll go into the second main point that we have for “Thinking, Fast and Slow.”

Stig Brodersen  20:59

So just real quick to give people an overview of the book, there are five main parts of this book. And the first one is called the Two Systems. The second one is called Heuristics and Biases. And three, four and five, that’s Confidence, Choices, and Two Selves. Basically, we’re giving you the highlights of each of these five points.

Let’s turn the attention to the stock market. I think the probably the simplest thing to discuss first, that is the whole concept of anchoring. And I know I tend to anchor a lot my stock picks, I just simply can’t help it. So if I bought Coca Cola at $40, then that is the average price. Now, my rational brain would think that Coca Cola doesn’t know I bought it at $40. The rest of the world doesn’t know I bought it at $40 and they probably don’t care. But in my head, that’s probably somewhat of the average price. So anything above that’s again, anything below that is a lot of loss. And it’s really easy to look at the price instead of the intrinsic value.

So I think before we dig more into that, you have a great point about this too, Preston. I think if we’re just really thinking about that whenever they were adjusting the stock price of the current stock picks.

Preston Pysh  22:16

So let me demonstrate this idea that Stig’s talking about with anchoring. And I’m going to ask the audience a question here. Was Gandhi 130 years old when he died? So think about your response. Most people would probably say no, I’m guessing. Now my next question is, well, how old was he? Okay, so now you’re going to come up with a figure and you’re going to say it to yourself right now, whatever that figure might be.

Now, let me change the table. So let’s say that I did not ask you any of those questions. And let’s say that I opened up with this question. Did Gandhi die at age 40? Well, if you said I don’t know or I don’t think so. Well, what age did he die at? Now, what would have been your response? Now you can see that depending on how your brain was thinking through that question, as I asked that, it’s really important to understand the anchoring piece. Most people when they’re asked this question of the 130, they then step down is he immediately thinking that he was obviously older when he died, so he might have been 90 years old or something like that close to the hundred-year mark because I anchored the question with a very high number. Now, whenever I would do the exact opposite, where I’d anchor the question with a really low number, people then had a guess that was more plausible towards the lower direction. And he took statistics on this and it was just an amazing example of the power of anchoring and how you’re influenced by suggestion.

Stig Brodersen  23:47

It is sort of the same thing as what if you’re looking at a new piece of cloth and you can see that it used to be 100 bucks, but now it’s on sale for 70 bucks. Yeah, that is your anchor.

Preston Pysh  23:59

I think that’s how a lot of these high-end brands operate is they put out these ridiculous prices. I mean, women’s purses, for example, is just totally crazy. You can go into some of these stores and it’s $3,000 for a purse. I mean, that’s nuts. But at the same time, you are basically anchoring the customer that everything in the store is that expensive. People see that as tremendous value.

Stig Brodersen  24:25

Yeah. And speaking of anchoring, because I promise that we will revert back to stock investing, that we all like to think that we make great stock picks. And if I buy a stock at $10, then I might be more inclined to sell it at $12 than sell it at $8 because then I can just tell myself, I can tell my friends, yes, I made a profit on that stock. Whereas you tend to hold stocks longer if you have made a loss because then you really haven’t lost money on that. And I think that’s something everyone is influenced by. We all put our stock picks in small boxes, and we want each box to be a success. So that’s why we hold on to lose for a long time.

Think about your home, if you had to sell your home, how inclined would you be to sell that home for less nominal value than you bought it for? You might not be thinking about interest rates or inflation. Anything else, you’re thinking about? What did I pay for it? How much am I selling it for? There was just so much bias on how you make decisions. I found that it was really, really interesting.

Preston Pysh  25:31

And we’ve talked about this in the past where people are drastically influenced about what they could lose versus what they could gain. And I know that we’ve talked about that discussion before, and it’s a very profound idea where most people are, if they gain something or they’re they come across a windfall of 100 bucks, they’re so much more likely to treat that money differently and just at ease, as they deserved it. Whereas if they lose $100 there’s this idea of loss aversion and they act completely differently in that direction.

So that gets right to the heart of what Stig is talking about with stocks that go down. People will not sell that. They’re going to hold on because they cannot really accept the idea of losing.

Let’s go ahead and talk about this next idea. And I really liked this idea. And I think that this is an important one to discuss. And that is this idea of overconfidence.

Stig Brodersen  26:27

I think the whole section about overconfidence was probably one of the most interesting sections. And well, first of all, I think Kahneman is really good at breaking people’s egos. For someone like me, I just think it’s really hilarious to read, and he has this very humorous approach to a lot of things.

26:45

So one of the things he’s saying is really not that special, you know that. You might think you’re unique, but basically, you aren’t. You might be thinking that other people are not unique at all, but they’re probably more unique than you think. Well, first of all, I think it was also meant to provoke but I also think it was really interesting that the more you know about yourself, the more biased in a way you can also be. At least that was somehow I took especially when it when it’s about yourself.

Preston Pysh  27:16

I think he got most of that from Nassim Taleb. You could see that he’s a pretty big fan of the Black Swan and they seem to love Nassim’s work as well. So maybe that he maybe you read a little bit too much Nassim Taleb when he was saying that.

Stig Brodersen  27:31

What I found was really interesting is how he’s saying that you can’t beat the stock market. He almost, in my opinion, had an arrogant approach to why you can’t do that. And in my opinion, I feel like he just didn’t do his homework.

Preston Pysh  27:50

Yeah, the irony of the statement and his talking about this in the confidence section. He’s confident that you can’t beat the stock market but yet, what is his expertise and actually understanding the valuation of equities and fixed income? Probably not that extreme. So I find the discussion in the book to be very ironic and very representative of what he’s trying to teach people.

Stig Brodersen  28:11

And he was having all these weird examples. So he was saying that “The more people trade, the more confident they are that the information. And as I can prove people that trade a lot, don’t beat the market.” I think that’s probably the worst hypothesis you can set up for whether or not you can beat the stock market. I mean, it just doesn’t make any sense to frame a question that way.

Preston Pysh  28:32

Well, it was an interesting discussion. So I think he had some really good points on this. But at the same time, I think that it was a little skewed. So his main point is that when you’re dealing with small numbers when you’re taking a sample of something, you’ve got to realize that the confidence level of that small sample is not nearly as good or representative of the actual total body of evidence.

So he had a person who did well in the stock market for seven years in a row. He would be quick to say, “Well, that does not prove that that person is an expert.” And I would agree with that because that’s a small sample set. It’s only seven years. He would probably go on to even say a person like Warren Buffett that’s been doing this for decades, still is a small sample set. And I think that’s where you start to get into maybe an understanding of the range. Okay. Just because there’s only 40. Let’s say you’re taking 40 years of examples. That’s a small number, I think a lot of people would say that only four samples of a data set are a small sample.

29:32

But what you’re not accounting for is that it’s deeper than 40 years. How many months is that? How many weeks is that? So then you can get a much larger and bigger number for the sample set whenever you’re looking at that. So I think it’s important to understand the fractal piece to what your data set is. And but I think that he does have a good point. I think that it’s good that people question, what’s the size of your sample set, and what probability does that produce and what’s that offset? So I think it’s a good decision.

But I think that he’s stepping into territory there that is somewhat questionable when I think that you actually do have to give some kudos and some credit to people that are able to do certain things and not just whitewash it as saying, “Oh, yeah, well, there’s not enough statistical evidence to prove that.”

Stig Brodersen  30:15

And basically, Preston, this comes down to a system one and system two. Again, I think it’s simply too complex to understand why Warren Buffet is speaking the market for someone like Kahneman. And don’t get me wrong, because Kahneman is extremely intelligent. He’s a professor and the Nobel Prize, but he’s researching so many different areas. And the stock market is really just one of them. Value Investing in that sense, it’s just one of them in stock market Calgary, and in that Calgary called value investing. Warren Buffett is one person.

So it’s just so easy for you, as an academic to say that that’s probably a small sample size and not really understand what this is all about. And just one thing I have to say about this, and I found that to be a huge problem, generally, for all the books that we’re reading. And very often we actually hear people saying that you can’t beat the stock market is that every time they compare to mutual funds, and they keep saying mutual funds prove that you can beat the stock market, I actually want to shout out to a blog post who wrote about mutual funds, saying why inherently there’s a problem speaking about mutual funds and proving why they can beat the market. I   think that’s the academic arrogance, saying, “As you can see, mutual funds can beat the market. Warren Buffett, that’s just a small sample size.”

Preston Pysh  31:37

It’s just a touch of overconfidence which is exactly the title of this chapter that we’re discussing. So I love the fact that the irony of the examples might be overconfidence themselves. And I think that that’s something that you know, we’ll leave up to the person reading and if you guys get out there and read this book, you can make your own decision on that. Stig and I might be biased and overconfident ourselves.

The next point is Choices. Stig, go ahead and give a quick summary that you got for Choices.

Stig Brodersen  32:07

So basically, when we talk about choices, we want to make the right decision. An example, if we’re talking about probabilities, we have a really hard time estimating what is the probability. So for instance, you would buy insurance. Now, I’m not saying that you shouldn’t buy insurance, but there’s a lot of different insurance that you shouldn’t buy. If you can afford the cost of damage should occur, then you probably shouldn’t buy that insurance because it’s really priced in that insurance. But what you’re paying for is basically not insurance, at least according to Kahneman, what you’re paying for is not to worry.

Preston Pysh  32:45

So the last part of the book that he talks about is the two selves. And this section here. He’s talking about your remembering self versus your experiencing self. And the example in the heuristic that he gets into is really this idea of one could really ruin or spoil the entire event for a person. So an example that’s provided is this idea of taking a 30-day vacation. Let’s say that the first 29 days of the vacation go really well, you really enjoy yourself. And then on the very last day, you have this horrible experience, that one experience totally overwhelms the whole 30-day experience where all you remember is a reality that bad event. And that’s the thing that leaves that stain on your mind. And that’s the thing that you recall whenever thinking about that, or referencing that in the future. So this is a really profound idea. I think that it has tremendous use and value for a person that’s trying to think about this and maybe see how maybe that’s impacted their own life in the past.

Stig Brodersen  33:45

One very interesting point that he brought out here in the last section is whether or not money can buy happiness. I think this is a discussion that you just hear over and over and over again and always love discussing. It’s always a lot of fun. It turns out that he made some research on this in the States. If you have $75,000 in the household a year, and that’s even in a high-cost neighborhood, then you’re happy. At least that is how much happiness money can buy. Well, supposedly up to that point, if you have less money, you’re everything else is legal, less happy. But when you have at least $75,000, it’s a ton of different factors that determines whether or not you’re happy with enough money…

Preston Pysh  34:25

Oh, my. And I really want to move on to the next section. But I’ve got a comment. I’m sorry. I really think that this whole money buys happiness thing. It really has nothing to do with the dollar figure. I think it has to do with are you happy with the value you’re adding to the world? And I think that’s really what it comes down to, folks. If you’re very satisfied with what you’re doing on a day to day basis, it typically has nothing to do with the money. It has everything to do with what that thing is that makes you unique and whether you get to exercise that daily by adding value to other people’s lives. And I think whenever you look at it from that context, I think the money thing is just a totally worthless discussion.

Stig Brodersen  35:11

Then just a final point about happiness. And I just have to say that because I live in Denmark, Denmark is the happiest place on earth. I think that’s so much fun. And I don’t want to bore you with like all the reasons why and why not.

Preston Pysh  35:28

How do they measure that? Do they have that they have a happiness meter that they put on people over there to determine how happy they are?

Stig Brodersen  35:35

You actually ask them. It is hard. And that’s also some of the critiques because there’s all dangerous research on this too. Happiness, you can’t really translate that in Danish, it doesn’t mean exactly the same as it does in English. So that’s also why people are saying there’s a lot of bias and so on. It’s a lot of fun. I do want to say one thing though. Denmark is the country in the world where we eat most antidepressant medicine. I’m not saying this is the reason why we are the happiest people on earth, but I just want to throw that in.

Preston Pysh  36:04

Oh, my goodness. So I think that this is a really fun point to end this book on because as people are listening to that conversation, and it generates this idea of well, how are they measuring that? How are they comparing that to another country? And it really gets into what metrics are you using in order to develop the information that you’re producing in order to develop your opinions and your ideas of what you think the truth is. Or I think that, interestingly, you brought some of that stuff up because I’m sure it’s making people think through well, what are the metrics? How is that being measured? How’s it being compared to another country with other people administering the happiness test, if you will? And I think it’s really important to think through that stuff.

And it’s really got to the heart of a lot of the discussion with the way that this book is teaching people how to think, to break out your fast and your slow thinking and how you conduct that analysis. Did you just take that on the face value with your intuition at the start and say, yeah, you know what I agree with Stig, I believe them? Or did your system two take over and really start doing some hardcore processing and trying to understand, hey, that’s a bunch of bunk?

So it’s an interesting discussion. It is a very interesting book. I think it’s a very long book. I would recommend the book “Influence” by Robert Cialdini over this book because I think it has a lot of the same points. And it’s a lot shorter and concise and I think that it was a little bit better writing in my opinion, just my personal opinion. Stig, would you agree? Did you like “Influence” better?

Stig Brodersen  37:33

Yeah.

Preston Pysh  37:34

It was a good book though. I really liked it. I think it had some really good points. And I think it had a lot of things that relate back to investing which I think is important as well. All right, so if you guys enjoyed this discussion, or you want to really learn more about the book “Thinking, Fast and Slow,” but you don’t want to take the 20 hours to read it. Go to our website, theinvestorspodcast.com and you can sign up on our email list.

Two times a month we send out emails and in the emails, we attach the executive summaries that we write for all the books that we read. So you can read this book, our executive summaries are five pages long, you can save a tremendous amount of time by reading these summaries and it costs nothing to sign up on our list. We don’t send any advertisements or spam. So just know that whenever you sign up, and if you guys don’t like being on the list, there’s a big unsubscribe button at the bottom so you can get off the list very easily.

Preston Pysh  40:02

So that’s all we have for you guys this weekend. We’ll see you guys next week.

Outro  41:59

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