by Rolf Dobelli
The overconfidence effect does not stop at economics: According to Taleb, 84 percent of Frenchmen estimate that they are above-average lovers. Without the overconfidence effect, that figure should be exactly 50 percent—after all, the statistical “median” means 50 percent should rank higher and 50 percent should rank lower. In another survey, 93 percent of the U.S. students estimated to be “above average” drivers. And 68 percent of the faculty at the University of Nebraska rated themselves in the top 25 percent for teaching ability. Entrepreneurs and those wishing to marry also deem themselves to be different: They believe they can beat the odds. In fact, entrepreneurial activity would be a lot lower if the overconfidence effect did not exist. For example, every restaurateur hopes to establish the next Michelin-starred restaurant, even though statistics show that most close their doors after just three years. The return on investment in the restaurant business lies chronically below zero.
Hardly any major projects exist that are completed in less time and at a lower cost than forecasted. Some delays and cost overruns are even legendary, such as the Airbus A400M, the Sydney Opera House, and Boston’s Big Dig. The list can be added to at will. Why is that? Here, two effects act in unison. First, you have the classic overconfidence effect. Second, those with a direct interest in the project have an incentive to underestimate the costs: Consultants, contractors, and suppliers seek follow-up orders. Builders feel bolstered by the optimistic figures, and through their activities, politicians get more votes. We will examine this strategic misrepresentation (chapter 89) later in the book.
What makes the overconfidence effect so prevalent and its effect so confounding is that it is not driven by incentives; it is raw and innate. And it’s not counterbalanced by the opposite effect, “underconfidence,” which doesn’t exist. No surprise to some readers: The overconfidence effect is more pronounced in men—women tend not to overestimate their knowledge and abilities as much. Even more troubling: Optimists are not the only victims of the overconfidence effect. Even self-proclaimed pessimists overrate themselves—just less extremely.
In conclusion: Be aware that you tend to overestimate your knowledge. Be skeptical of predictions, especially if they come from so-called experts. And with all plans, favor the pessimistic scenario. This way, you have a chance of judging the situation somewhat realistically.
Back to the question from the beginning: Johann Sebastian Bach composed 1,127 works that survived to this day. He may have composed considerably more, but they are lost.
16
Don’t Take News Anchors Seriously
Chauffeur Knowledge
After receiving the Nobel Prize in Physics in 1918, Max Planck went on tour across Germany. Wherever he was invited, he delivered the same lecture on new quantum mechanics. Over time, his chauffeur grew to know it by heart: “It has to be boring giving the same speech each time, Professor Planck. How about I do it for you in Munich? You can sit in the front row and wear my chauffeur’s cap. That’d give us both a bit of variety.” Planck liked the idea, so that evening the driver held a long lecture on quantum mechanics in front of a distinguished audience. Later, a physics professor stood up with a question. The driver recoiled: “Never would I have thought that someone from such an advanced city as Munich would ask such a simple question! My chauffeur will answer it.”
According to Charlie Munger, one of the world’s best investors (and from whom I have borrowed this story), there are two types of knowledge. First, we have real knowledge. We see it in people who have committed a large amount of time and effort to understanding a topic. The second type is chauffeur knowledge—knowledge from people who have learned to put on a show. Maybe they have a great voice or good hair, but the knowledge they espouse is not their own. They reel off eloquent words as if reading from a script.
Unfortunately, it is increasingly difficult to separate true knowledge from chauffeur knowledge. With news anchors, however, it is still easy. These are actors. Period. Everyone knows it. And yet it continues to astound me how much respect these perfectly coiffed script readers enjoy, not to mention how much they earn, moderating panels about topics they barely fathom.
With journalists, it is more difficult. Some have acquired true knowledge. Often they are veteran reporters who have specialized for years in a clearly defined area. They make a serious effort to understand the complexity of a subject and to communicate it. They tend to write long articles that highlight a variety of cases and exceptions. The majority of journalists, however, fall into the category of chauffeur. They conjure up articles off the tops of their heads or, rather, from Google searches. Their texts are one-sided, short, and—often as compensation for their patchy knowledge—snarky and self-satisfied in tone.
The same superficiality is present in business. The larger a company, the more the CEO is expected to possess “star quality.” Dedication, solemnity, and reliability are undervalued, at least at the top. Too often shareholders and business journalists seem to believe that showmanship will deliver better results, which is obviously not the case.
To guard against the chauffeur effect, Warren Buffett, Munger’s business partner, has coined a wonderful phrase, the “circle of competence”: What lies inside this circle you understand intuitively; what lies outside, you may only partially comprehend. One of Munger’s best pieces of advice is: “You have to stick within what I call your circle of competence. You have to know what you understand and what you don’t understand. It’s not terribly important how big the circle is. But it is terribly important that you know where the perimeter is.” Munger underscores this: “So you have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.”
In conclusion: Be on the lookout for chauffeur knowledge. Do not confuse the company spokesperson, the ringmaster, the newscaster, the schmoozer, the verbiage vendor, or the cliché generator with those who possess true knowledge. How do you recognize the difference? There is a clear indicator: True experts recognize the limits of what they know and what they do not know. If they find themselves outside their circle of competence, they keep quiet or simply say, “I don’t know.” This they utter unapologetically, even with a certain pride. From chauffeurs, we hear every line except this.
17
You Control Less Than You Think
Illusion of Control
Every day, shortly before nine o’clock, a man with a red hat stands in a square and begins to wave his cap around wildly. After five minutes, he disappears. One day, a policeman comes up to him and asks: “What are you doing?” “I’m keeping the giraffes away.” “But there aren’t any giraffes here.” “Well, I must be doing a good job, then.”
A friend with a broken leg was stuck in bed and asked me to pick up a lottery ticket for him. I went to the store, checked a few boxes, wrote his name on it, and paid. As I handed him the copy of the ticket, he balked: “Why did you fill it out? I wanted to do that. I’m never going to win anything with your numbers!” “Do you really think it affects the draw if you pick the numbers?” I inquired. He looked at me blankly.
In casinos, most people throw the dice as hard as they can if they need a high number and as gingerly as possible if they are hoping for a low number—which is as nonsensical as football fans thinking they can swing a game by gesticulating in front of the TV. Unfortunately they share this illusion with many people who also seek to influence the world by sending out the “right” thoughts (i.e., vibrations, positive energy, karma . . . ).
The illusion of control is the tendency to believe that we can influence something over which we have absolutely no sway. This was discovered in 1965 by two researchers, Jenkins and Ward. Their experiment was simple, consisting of just two switches and a lig
ht. The men were able to adjust when the switches connected to the light and when not. Even when the light flashed on and off at random, subjects were still convinced that they could influence it by flicking the switches.
Or consider this example: An American researcher has been investigating acoustic sensitivity to pain. For this, he placed people in sound booths and increased the volume until the subjects signaled him to stop. The two rooms, A and B, were identical, save one thing: Room B had a red panic button on the wall. The button was purely for show, but it gave participants the feeling that they were in control of the situation, leading them to withstand significantly more noise. If you have read Aleksandr Solzhenitsyn, Primo Levi, or Viktor Frankl, this finding will not surprise you: The idea that people can influence their destiny, even by a fraction, encouraged these prisoners not to give up hope.
Crossing the street in Los Angeles is a tricky business, but luckily, at the press of a button, we can stop traffic. Or can we? The button’s real purpose is to make us believe we have an influence on the traffic lights, and thus we’re better able to endure the wait for the signal to change with more patience. The same goes for “door-open” and “door-close” buttons in elevators: Many are not even connected to the electrical panel. Such tricks are also designed in open-plan offices: For some people it will always be too hot, for others, too cold. Clever technicians create the illusion of control by installing fake temperature dials. This reduces energy bills—and complaints. Such ploys are called “placebo buttons” and they are being pushed in all sorts of realms.
Central bankers and government officials employ placebo buttons masterfully. Take, for instance, the federal funds rate, which is an extreme short-term rate—an overnight rate, to be precise. While this rate doesn’t affect long-term interest rates (which are a function of supply and demand, and which are an important factor in investment decisions), the stock market, nevertheless, reacts frenetically to its every change. Nobody understands why overnight interest rates can have such an effect on the market, but everybody thinks they do, and so they do. The same goes for pronouncements made by the chairman of the Federal Reserve; markets move, even though these statements inject little of tangible value into the real economy. They are merely sound waves. And still we allow economic heads to continue to play with the illusory dials. It would be a real wake-up call if all involved realized the truth—that the world economy is a fundamentally uncontrollable system.
And you? Do you have everything under control? Probably less than you think. Do not think you command your way through life like a Roman emperor. Rather, you are the man with the red hat. Therefore, focus on the few things of importance that you can really influence. For everything else: Que sera, sera.
18
Never Pay Your Lawyer by the Hour
Incentive Super-Response Tendency
To control a rat infestation, French colonial rulers in Hanoi in the nineteenth century passed a law: For every dead rat handed in to the authorities, the catcher would receive a reward. Yes, many rats were destroyed, but many were also bred specially for this purpose.
In 1947, when the Dead Sea Scrolls were discovered, archaeologists set a finder’s fee for each new parchment. Instead of lots of extra scrolls being found, they were simply torn apart to increase the reward. Similarly, in China in the nineteenth century, an incentive was offered for finding dinosaur bones. Farmers located a few on their land, broke them into pieces, and cashed in. Modern incentives are no better: Company boards promise bonuses for achieved targets. And what happens? Managers invest more energy in trying to lower the targets than in growing the business.
These are examples of the incentive super-response tendency. Credited to Charlie Munger, this titanic name describes a rather trivial observation: People respond to incentives by doing what is in their best interests. What is noteworthy is, first, how quickly and radically people’s behavior changes when incentives come into play or are altered, and second, the fact that people respond to the incentives themselves, and not the grander intentions behind them.
Good incentive systems comprise both intent and reward. An example: In ancient Rome, engineers were made to stand underneath the construction at their bridges’ opening ceremonies. Poor incentive systems, on the other hand, overlook and sometimes even pervert the underlying aim. For example, censoring a book makes its contents more famous, and rewarding bank employees for each loan sold leads to a miserable credit portfolio. Making CEO pay public didn’t dampen the astronomical salaries; to the contrary, it pushed them upward. Nobody wants to be the loser CEO in his industry.
Do you want to influence the behavior of people or organizations? You could always preach about values and visions or you could appeal to reason. But in nearly every case, incentives work better. These need not be monetary; anything is possible, from good grades to Nobel Prizes to special treatment in the afterlife.
For a long time I tried to understand what made well-educated nobles from the Middle Ages bid adieu to their comfortable lives, swing themselves up onto horses, and take part in the Crusades. They were well aware that the arduous ride to Jerusalem lasted at least six months and passed directly through enemy territory; yet they took the risk. And then it came to me: The answer lies in incentive systems. If they came back alive, they could keep the spoils of war and live out their days as rich men. If they died, they automatically passed on to the afterlife as martyrs—with all the benefits that came with it. It was win-win.
Imagine for a moment that, instead of demanding enemies’ riches, warriors and soldiers charged by the hour. We would effectively be incentivizing them to take as long as possible, right? So why do we do just this with lawyers, architects, consultants, accountants, and driving instructors? My advice: Forget hourly rates and always negotiate a fixed price in advance.
Be wary, too, of investment advisers endorsing particular financial products. They are not interested in your financial well-being, but in earning a commission on these products. The same goes for entrepreneurs’ and investment bankers’ business plans. These are often worthless because, again, the vendors have their own interests at heart. What is the old adage? “Never ask a barber if you need a haircut.”
In conclusion: Keep an eye out for the incentive super-response tendency. If a person’s or an organization’s behavior confounds you, ask yourself what incentive might lie behind it. I guarantee you that you’ll be able to explain 90 percent of the cases this way. What makes up the remaining 10 percent? Passion, idiocy, psychosis, or malice.
19
The Dubious Efficacy of Doctors, Consultants, and Psychotherapists
Regression to Mean
His back pain was sometimes better, sometimes worse. There were days when he felt like he could move mountains, and those when he could barely move. If that was the case—fortunately it happened only rarely—his wife would drive him to the chiropractor. The next day he felt much more mobile and recommended the therapist to everyone.
Another man, younger and with a respectable golf handicap of 12, gushed in a similar fashion about his golf instructor. Whenever he played miserably, he booked an hour with the pro, and, lo and behold, in the next game he fared much better.
A third man, an investment adviser at a major bank, invented a sort of “rain dance” that he performed in the restroom every time his stocks had performed extremely badly. As absurd as it seemed, he felt compelled to do it: Things always improved afterward.
What links the three men is a fallacy: the regression-to-mean delusion.
Suppose your region is experiencing a record period of cold weather. In all probability, the temperature will rise in the next few days—back toward the monthly average. The same goes for extreme heat, drought, or rain. Weather fluctuates around a mean. The same is true for chronic pain, golf handicaps, stock market performance, luck in love, subjective happiness, and test scores. In short, the crippling back pain would most l
ikely have improved without a chiropractor. The handicap would have returned to 12 without additional lessons. And the performance of the investment adviser would also have shifted back toward the market average—with or without the restroom dance.
Extreme performances are interspersed with less extreme ones. The most successful stock picks from the past three years are hardly going to be the most successful stocks in the coming three years. Knowing this, you can appreciate why some athletes would rather not make it on to the front pages of the newspapers: Subconsciously they know that the next time they race, they probably won’t achieve the same top result—which has nothing to do with the media attention, but with natural variations in performance.
Or take the example of a division manager who wants to improve employee morale by sending the least motivated 3 percent of the workforce on a course. The result? The next time he looks at motivation levels, the same people will not make up the bottom few—there will be others. Was the course worth it? Hard to say, since the group’s motivation levels would probably have returned to their personal norms even without the training. The situation is similar with patients who are hospitalized for depression. They usually leave the clinic feeling a little better. It is quite possible, however, that the stay contributed absolutely nothing.
Another example: In Boston, the lowest-performing schools were entered into a complex support program. The following year, the schools had moved up in the rankings, an improvement that the authorities attributed to the program rather than to natural regression to mean.
Ignoring regression to mean can have destructive consequences, such as teachers (or managers) concluding that the stick is better than the carrot. For example, following a test, the highest-performing students are praised and the lowest are castigated. In the next exam, other students will probably—purely coincidentally—achieve the highest and lowest scores. Thus, the teacher concludes that reproach helps and praise hinders: a fallacy that keeps on giving.
