Trust is at the heart of everything we do, but not all apparent experts can be trusted.
I received this quote from James Clear before Christmas:
“An expert is someone who, over many years, manages to remain confident enough to keep trying, and humble enough to keep learning.”
I could add much more to that (e.g. need for clear evidence of success; a willingness to share; a willingness to listen), but that definition is a good starting point for today.
I believe that all of you have the ability to become expert investors, and to meet James’s definition. I have covered that previously e.g. Why You Can Beat The Pros.
But today my focus is on where experts and trust collide – who can you trust? The answer is in three parts:
- The problem with experts
- The problem with the rest of us
- How investors should approach this problem
To be clear, investors do need to deal with this matter – the cost of getting this wrong can range from expensive to losing much of your life savings.
Trust is a huge issue for the financial services industry, including the retail investment sub-sector – which is my territory.
It is an even bigger issue for the retail investors (that’s you) who engage with that industry.
Us humans have a need for experts. It is how society is organised and grows, and that has always been the case. When you are sick you need a doctor, not someone with a clever argument on Twitter. When your car breaks down you want some mechanic, not a quip by a drive-by comedian. We cannot reject expertise altogether – yet the clamour to do so is deafening.
The tendency to distrust experts appears to have accelerated in the last 15 years, coinciding with the rise of social media as a new tool for tribalism. Not coincidentally, it has also occurred at a time of growing income inequality.
This tendency is not new. A book in 1930 by a Spanish philosopher, called “The Revolt Of The Masses”, noted that people were no longer trusting of experts – also a time of poverty and polarisation. Perhaps we should just accept that this lack of trust always exists to some extent, with various triggers from innumeracy to ignorance to healthy scepticism. With the addition of social media fuel to the sceptic fire in the last 15 years, the dial has moved more to the voice of the idiots than the healthy sceptics.
This scepticism is part of the experts making.
The Problem With Experts
Nobel Prize winner Daniel Kahneman (DK) highlights many strange traits in the human condition, one of which is our apparent inability to acknowledge the full extent of our ignorance and the uncertainty of the world in which we live.
The other side of the coin is that we crave certainty in the same way we crave food and sleep. Taken together, these two traits have some very unhelpful consequences.
For example, many experts deliver predictions with huge certainty and gushing confidence, all too often over-confidence. Many of us without that expertise, and who aren’t naturally in the sceptic camp, swarm to that certainty and the glow of expert confidence.
On the first trading day of 2022 one influential media outlet proclaimed that there was already a “New Year boom” (based on one day!) and confidently announced “here’s what you should buy”.
Sadly, the over-confidence of those experts leads to error strewn decisions. These are the dangerous experts – they know they are skilled, but do not know the boundaries of their skill – humility is not likely to be a natural part of their persona. Confidence is often confused with accuracy. Investors are often lulled into funds by confident sounding fund managers, who are in turn given air-time by a voracious media fed by cute PR companies – think Woodford.
When confident experts inspire belief, and create a fan club, “logic withers and dies”.
Example 1: Dangerous Doctors? (with apologies to all those I know well!)
DK presents one intriguing example. Lew Goldberg conducted a study with a group of radiologists to determine how they diagnosed stomach cancer, to test whether their decisions could be captured by an algorithm. The doctors indicated that there were seven major signs.
“There were obviously many different plausible combinations of these seven cues, and the doctors had to grapple with how to make sense of them in each of their many combinations. The size of an ulcer might mean one thing if its contours were smooth, for instance, and another if its contours were rough. Goldberg pointed out that, indeed, experts tended to describe thought process as subtle and complicated and difficult to model.”
Next, the researchers showed the group of doctors 96 different stomach ulcer images and asked each doctor to rate the probability of the ulcer on a scale from “definitely malignant” to “definitely benign”. Without telling the doctors, they also showed each image to them twice by randomly mixing in duplicate images of each ulcer. Lastly, Lew and his (non-medical) research team created their own simple model which equally weighted the seven factors the radiologist had provided.
When the results came back, the research team was shocked.
The good news was that the simple algorithm (basically a check-list in this case) was extremely good at predicting the doctors’ diagnoses.
“The doctors might want to believe that their thorough processes were subtle and complicated, but a simple model captured these perfectly well”
In contrast, the doctors’ diagnoses, based on their skills and experience, were all over the place. Not only did they not agree with each other, but when presented with duplicates of the same ulcer, every doctor had contradicted himself with more than one diagnosis.
The final insult for the doctors was that the check-list not only did better than the group of doctors, but better than the single best doctor.
The important conclusion from this research is that a simple check-list constructed on the back of an envelope is often good enough to outdo expert judgment. This logic can be applied in many domains, ranging from the choices of medical treatments by doctors to the selection of stocks by fund managers. On which note…
Example 2: Dangerous Fund Managers? (ditto, apologies…)
James Montier presents another study, closer to home (Torngren and Montgomery, 2004).
Participants, both students and professional investors, were asked to select one stock from a pair of stocks which they thought would outperform each month, and also state how confident they were about their selections. All the stocks were well known big companies, and everyone knew the name and industry and had 12 months prior performance to consider.
That the results were shocking is not the biggest finding. The greatest shock was that when the professionals were 100% sure they were correct, they were actually right less than 15% of the time!
Additionally, they were all asked what was the biggest input to their decision, whether the information provided or otherwise. The students admitted that the biggest input was guesswork. In contrast the professionals’ biggest input was “other knowledge” – they believed they had some special insight beyond the information provided, because they were expert professionals.
Why do investors, amateur and professional, stubbornly believe that they have some special insight such that they can do better than the market?
We KNOW that 94% of fund managers cannot consistently beat an undemanding benchmark – that is based on our own Vintage Research, and is confirmed by other research stretching back decades. For the avoidance of doubt, we are never, never, challenged on that statement by the fund industry.
Yet to be fair to the retail fund industry, at least their performance numbers are public. There are many institutions and discretionary fund managers who would definitely not want their performance numbers made public – their very survival is based on them being largely unchallenged by clients.
The Problem With The Rest Of Us
When we collide with experts, we typically react in one of two ways:
The sceptical range from the angry to the constructive. The former has a personality problem, while the latter are thoughtful. Our service cannot help the angry, but we can help those who are sceptical but still have open minds.
It is amongst those who are inclined to be accepting of experts that there is the greatest scope for problems, whether damage to your wealth or health or otherwise.
This blog was first written on 7th January 2022, on the research hub of our sister company FundExpert. This will be particularly interesting for those who are contemplating using our discretionary fund management service (DFM).