This is Masters in Business with Barry Ridholds on Bloomberg Radio. This week on the show, I have an extra special guest. I know you guys give me grief for saying that every week, but I really have an extra special guest, Professor Danny Kahneman, winner of the two thousand and two Nobel Prize in Economics, which is quite a feat when you realize that he's not an economist. He's a cognitive psychologist, author of the book Thinking Fast and Slow before we get to the podcast, which is really quite fascinating. Just a quick funny story. So we finished doing the interview and we're heading out of the Bloomberg building where you're heading to, Oh, I'm going over here. Oh I'm heading in that same direction, I tell Danny, which is what he insists everybody call him. And so we take a subway downtown and we're get out at Grand Central and we're walking someplace and and he said, as to me, listen, you don't have to walk me to where I'm going. I'm in New York right now where I am? And I said, well, to tell you the truth, it's two o'clock. I haven't had lunch yet. A block from where your destination is. Is this lovely um sandwich shop called Alidoro, just open the midtown. There's a Soho branch. It's really good. I'm just heading in your direction anyway. So he looks at me and says, the sandwich is really that good. Yes, they're delicious. So long story short, we go into this place. It's essentially a takeout joint with one long picnic table on the back. Most people um take sandwiches out. And it's two o'clock so the rush lunch hour rush is over, so I we order sandwiches. Takes a few minutes. I kind of put it, sit him down at the table, and I said, I'll go get the sandwiches. And as I'm coming back to the table, there is Professor Khneman sitting at a picnic table surrounded by I don't know a dozen millennials, kids who could have been in his class a couple of years ago at Princeton, and they're just holy oblivious to this kindly professor sitting amongst them. Here's a brilliant thinker who changed the way we think about how we think, and just everybody completely wholly unaware that that brilliance is in their midst. Then it's the whole thing just cracked me up. I found the interview to be absolutely fascinating. I think you will also, so, with no further ado, my conversation with Danny Khneman. This is Masters in Business with Barry Ridholts on Bloomberg Radio. Our special guest this week. And I know I say this all too often, but we really do have an extra special us this week. His name is Professor Daniel Kaneman. He taught at the Woodrow Wilson School at Princeton, both in psychology and public affairs. He is a fellow at the Center for Rationality at Hebrew University, winner of the Nobel Prize in Economic Sciences as well as the Lifetime Contribution Award of the American Psychology Association UH and he is a recipient of the Presidential Medal of Freedom. I could go on and on about his curriculum vita, but I would rather jump right into this. Danny Kahneman, Welcome to Bloomberg. Pleased to be here, so I'm excited to talk to you about so many different things. Let's let's start way back at the beginning. You you began your academic career in Israel. Did did you expect to spend the rest of your life working in academia? Oh? Yeah, I mean I expected to be a professor when I was a kid. And so you win the Nobel Prize in two thousand and two, not for psychology, which is your field of study, but but for economics. How does the psychologist win a prize for economics? Well, I mean there is no Nobel in psychology, but we wanted in economics for work that is psychological. Uh, when it's you and he didn't actually win this because they don't give it posthumously, but you know, I always felt it it's a joint prize because the prize was awarded for work we had done together, and it was work that influenced economics. So it's under influence in general that you get a Nobel, not on the quality of the work necessary. So so let's talk about your colleague, a most diverse key in your book Thinking Fast and Slow, you described first seeing him speak. I think it was around nineteen sixty nine and the subject was, uh, do people make good intuitive statistical assumptions? Did you know right away the two of you were destined to be research partners? No? But what happened was he visited seminario was teaching. I mean I invited him and he spoke about some research that was being done in Michigan at the time on whether people are good intuitive statisticsians, and their conclusion was that they are. And so we had very counterintuitive well it's now counterintuitive, at that time, it sounded quite intuitive, and we had a very heated discussion. You know, they had those in Israel, and it was a very Israeli type conversation and we enjoyed it, both of us. We decided to have lunch together the following Friday, and there we we discussed ideas over that lunch, and we didn't know that it was going to shape our lives, but we had a pretty good inkling of what we wanted to do next. So the two you established a cognitive basis for analyzing common human errors and how they arrive from biases. How did you, guys, happen across across that discovery. We started, you know, from a combination of what Amos knew and what I was specialized in, and my specialty at the time was visual perception, and in visual perception you have illusions and analyzing the illusions is interesting because the illusions teach you something about the mechanism of normal perception. And Amos was an expert on decision theory and on formal analysis, and we complemented each other very well. And the idea that the research that we developed eventually was really a research on cognitive illusions and where they come from. And we proposed a mechanism and mechanisms we call we call those heuristics, and now have a somewhat different interpretation, not very different, but slightly different from the one we had at that time. I mean, the general idea is quite simple. You ask people a complicated question like what is the probability of an event? And they can't answer it because it's very difficult. But there are easier questions that are related to that one that they can answer, such as, this is a surprising event that is something that people know right away? Is it a typical result of that kind of mechanism? And people can answer that right away. So, and what happens is people take the answer to the easy question, they use it to answer the difficult question, and they think they have answered the difficult question. In fact, they haven't. They answered an easier one. So that's why the mechanism that we studied. You mentioned that your view on heuristics have changed somewhat over the years. What's the difference between what you live today and and way back when. Well, we started out with what we call a limited number of heuristics, and they became quite well known because we have a paper that we published in nine four that in we published it in Science magazine, so it was widely read across many disciplines. And in that paper we spoke about three major heuristics, and we analyze the biases that these heuristics lead to. And many people would know their name from if they went to business school. So it's representativeness, it's availability and anchoring. What I'm thinking of now is that there is a more general process, and that's the process I described a minute ago. They called that attribute substitution. It's to substitute one question for another's. So instead of answering the complex, difficult question, you answer what you can, which is the easier question. That's right. So if I ask you an example that comes to mind, how happy are you these days? Now? You know your mood right now? You're very likely to tell me your mood right now. And think that you have answered the more general question of how happy are you these days? So that's that's another example. There are many like them. I'm Barry Ridholts. You're listening to Masters in Business on Bloomberg Radio. My special guest today is Nobel Prize winning psychologist Danny Kahneman, who has specialized in both cognitive and decision making processes. Let's let's jump right into some of the things that you discussed in Thinking Fast and Slow, a book that I found to be just right in the sweet spot of my confirmation bias. Who was everything I hoped it to be. You talked about what you see is all there is? When when this cussing systems one and two, it's almost a theme throughout the book, explain what that is? What you see is all there is? Well, people are really not aware of information that they don't have, and so the the idea which is emphasized in the book is that you take whatever information you have and you make the best story possible out of that information. And the information you don't have you don't feel that it's necessary. And I have an example that that I think brings that out. If I tell you about a national leader, that she is intelligent and firm. Now do you have an impression already whether she's a good leader or a bad leader, And you certainly do. She's a good leader. Now the third word that I was about to say is corrupt. But you know, the point being that you didn't wait for information that you didn't have, who formed an impression as we were going with the information you did have, And this is what you see, is all there is the working assumption amongst people who are trying to draw a conclusion from available information is they failed to calculate the impact of data they're either unaware of, or don't know or simply haven't encountered. That's I mean, people, If what people are trying to do is to make the best story possible out of the information they have, then this is what they're going to do. And that the measure of confidence that people have in uh, in their beliefs, in their opinions, there's really a reflection of the quality of the story that they've told them. So, so let's talk about that narrative because it's it's one of my favorite errors in investing is that we tell ourselves these complex narratives that seem to fit whatever information is in front of us, and that very much creates a risk that the narrative, as emotional and compelling as it might be, is possibly misleading. How does that fit into your work? I think the same. Talib has a very nice example in his in his book The Black Swan. It's an example of that happened at Bloomberg on Bloomberg News, and it happened the day that Saddam was court, and something happened in the bond market shortly thereafter. I forget whether it rose or it felt and the headline was Saddam Court and investors are fleeing from risk. And then a few hours later the market reversed and there was a headline that said, Saddam Court investors feel more secure taking risk. So now what happened was obviously it's not plausible that that you could explain to opposite consequences by the same thing, but you can make a very good story and what happens and commentators and Bloomberg Radio and all other pundits what they do there is a salient event today. So when you're looking at what happened in the market, you're looking back and you see that salient event, and irresistibly you think there is a causal connection. So whatever happened in the market you attribute to the salient event, went up, went down, whatever it's always it makes a good story. I have a very vivid recollection early in the two thousand and three Iraq invasion there was a important, highly regarded mosque that was blown up by American warplanes. And the headline, and I don't remember it was the Times of the Wall Street Journal, but it was a big publication oil prices skyrocket on mosque accidentally being blown up. And later that day, so you're looking at this online and later that day the oil prices had come back down, and it was the same headline, only changing the conclusion mass destroyed, oil prices remains stable. Well, if it's going up and down after the event, it means the event isn't really significant, is it? Well, clearly. So let's talk a little bit about some of the biases, those three biases you discovered early on availability, anchoring, and representativeness. First, these are three enormous biases. First question, why publish in Discover magazine or Science magazine as opposed to some staid academic journal. Oh, we had done our homework. I mean we published in State academic journalist first, and then what we published in Science, which you know is a scientific magazine. I mean it's not it's a popular magazine. No it's not. No, it's a it's a Science is a professional magazine, but it's a it's addressed to scientists of all disciplines. But you know, it's a it's a perfectly respectable scientific magazine. No, we did. We we were academics. We published academically. We didn't publish and discover. They looked us up and they interviewed us and they wrote about us, but we didn't seek that out. We were really academics. We were not trying to influence the world. And whatever happened happened, but that wasn't really what we intended. Did you have any sense of the enormity of these three particular biases early on, Well, when we wrote for Science, we had a sense that this was an important story. We really did not anticipate the impact that it had on many fields, including investment and the law, and and and even economics. It had a lot of influence and that we didn't anticipate. Really. So so let's talk about a couple of these. You mentioned availability bias, it's just the information you have. Anchoring is an enormous factor in things like negotiations, in pricing. I love the story of just asking people. Ask a group of people in a room what the first digit of their phone number is, and then ask them a separate, unrelated question. A higher digit will yield a higher number on the unrelated question, and a lower first digit yields a low How did how did that discovery come about? Well, actually it takes a little more than that, but I'll give you an example. Uh, in the example of negotiation, many people think that you have an advantage if you go second, but actually the advantage is going first throughout the first number, and that's where you're throughout. And and the reason is something in the way the mind works. And the mind works, it tries to make sense whatever you put before it. So this built in tendency that we have of trying to make sense of everything that we encounter, that is a mechanism for anchoring. I'm Barry Ridholts. You're listening to Masters in Business on Bloomberg Radio. My special guest today is Nobel Prize winning psychologist Danny Kahneman, who has specialized in both cognitive and decision making processes. Let's talk a little bit about biases and money. Since this is Bloomberg and many of our listeners are investors, I want to start with prospect theory, which is something that's I find absolutely fascinating. The basic idea is that we feel losses much more severely than we enjoy gains. The first question I have for you about this is how did you discover this? Well, the idea that came first or the was that the standard financial analysis and which called the rational age model, fails in an important way. And in the rational agent model, you should always be thinking in terms of wealth. You know, what will be my wealth if this happens? What will be my wealth if that happens? And all the theory is based on the idea that you are thinking in terms of your wealth. But it turns out you're not thinking in terms of your wealth at all. You're thinking in terms of gains and losses. You're thinking in terms of changes of wealth. So that was the first thing that that was important to establish. It was clear Homo economists is what the professors call it, not a really good representation of how people behave. That's right, and you know that this is sort of immediately obvious that people don't think in terms of their wealth. And it's easy to show that that they don't because you can describe the same decision which in the same in terms of wealth. You can give it two different descriptions and people will make different choices depending on whether it's resented in gains and losses. So that were the first discovery, if you will, I mean, you know it had been stated before by the way Marco Witch Harry Marco which he had he had written. He had written one article on this about changes being important. He didn't follow through, and we came upon us and we did follow through. Now, once you have that that people are thinking gains and losses, it's easy to see that there is an asymmetry. That is that losses, as we said, loom larger than gains. And we even have a pretty good idea of by how much do they loom larger than gains about two to one. And you know an example how to bring that out is I'll offer you a gamble on the toss of a coin. You know, if it chose tales, you lose one hundred and if it chose heads, you win X. Now what would ex have to be for that gamble to become really attractive to you? Well, more than a hundred, so it's more than Actually you're a professional. There is a difference of professionals than others most people, and that's been well established. The men more than two hundred really, so they want two to one odds, which is it's not the odds, I mean the odds I went to one. It's equal chance to payout. It's the payout has to be to to one, meaning that it takes two hundred dollars of potential gain to compensate for one hundred dollars of potential loss when the chances of the two are equal. So that's loss of version. Terms out that loss of version has enormous consequence, enormous absolutely so. So that leads to a couple of really interesting questions. The first one is what is it about losses that makes them so much more painful than gets are pleasurable? In other words, why does this two to one risk of loss of version? Why does this even exist? Well, I mean you know this, this is evolutionary. I mean you you would imagine that in evolution, threats are more important than opportunities. That makes a lot of sense, And so it's a very general phenomenon that sort of bad things. So the preemptal are stronger than good things in our experience. So loss of version is a special case of something much broader. So there's always another opportunity coming along, another game, another deer coming by, but an actual genuine loss. Hey, that's permanent. You don't recover from that. That's right anyway, you take it most seriously. So there is a deer in your sights and a lion, you are going to be busy about the lion and not about the deer. Makes sense. That leads to the obvious question, well, what can investors do to protect themselves against this hardwired Uh? Well, loss of her Uh there's everything they can do. One is not to look at their results, not to look too often at how well they're doing. And today you could look tick by tick, minute by minute. The worst thing, it's a very very bad idea to look too often. When you look very often, you attempted to make changes. And where individual investors lose money is when they make changes in their allocation virtually on average. Whenever an investor makes a move, it's likely to lose money because they are professionals on the other side, betting against the kind of moves that individual investors. I'm Barry Hults. You're listening to Masters in Business on Bloomberg Radio. My special guest today is Danny Kahneman. He is the Nobel Prize winning psychologist formerly professor at Princeton who has had an enormous influence on the fields of economics and investing. Let's get right back to the question of investing and the professionals versus the amateurs. Do we see the same sort of biases and errors amongst the professionals. They're clearly much attenuated among professionals. So I'll give you an example. I mean, and that's the biggest example. It's what makes lots of version important. If I ask you, would you take a gamble if I ask a regular person in the street, Not you, because you're a professional, But if I ask a regular person in the street, would you take a gamble that if you lose, you lose a hundred dollars. If you win, you win a hundred and eighty on the toss of a coin. That's a no brainer. Well, it's a no brainer for professionals. Most people don't like it. Really do that all day long? Yeah, because you're a professional. Now, when you ask the same people in the street, Okay, don't want this one? Would you take ten? So we'll toss tin coins and every time, if you lose, you lose a hundred, and if you win, you win a hundred and eighty. Everybody wants the tin. Nobody wants the one. So, in other words, they think the mathistatistics in repeated play. When the game is repeated, then people see they become much closer to risk neutral and they see the advantage of gambling. Now professionals are in a repeated play situation. That's the biggest difference, And so they view each decision that they make out of a stream of decision that they're going to make. Now, this, by the way, is true for investors as well. One question that I asked people when I tell them about that, So you've turned down a hundred hundred and eighty now, but you would accept ten of those? Now, are you on your deathbed? That's the question I ask if that the last decision you're going to make, And clearly they are going to be more opportunities to gamble, perhaps not exactly the same gamble, but there will be many more opportunities. You need to have a policy for how you deal with risks and then make your decisions, your individual decisions, in terms of a broader policy. Then you will be much closer to rationality. But on the single flip of a coin, the average individual is going to look at this and say, hey, I'll feel foolish if I lose a hundred, even though the payout is greater than my potential law that's exactly what happens, and you shouldn't feel that way. I mean, now, it's true that you will feel like a fool. It's very closely related to what you see as all. There is that as we tend to see decisions in isolation, we don't see a decision about whether I take this gamble as one of many similar decisions that I'm going to make in future. So are people overly outcome focused to the detriment of process? What they are We call that narrow framing. They viewed the situation narrowly, and that is true in all domains. So, for example, we said that people on my opic that they have a narrow time horizon. To be more rational, you want to look further in time, and then you'll make better decisions. If you're thinking of where you will be, you know, a long time from now. It's completely different from thinking about how will I feel tomorrow If I make this bit and I lose, I recall reading about a study and I hope I don't mangle this too badly where they would take a photo of somebody and then using software age their face, and then when they were would ask the people who had the current photo of their own face. They would get a very different answer than the group that we're better able to imagine themselves twenty years alter. Yeah, that's about saving. I mean what actually happens is that when you show people morphed image of their face as an old person, their tendency to save increases, so it's easier for them to identify with their future self. But in general that's not what we do. People aren't especially good about that. Let's talk about being wrong and being able to admit that you're wrong. John Kenneth gale Breath once favor You famously said, given the choice between changing one's minds and proving there's no need to do so most people get busy on the proof. You called this theory induced blindness. So why are we so unwilling to admit when we're wrong. You know, you try to make the best story possible, and the best story possible includes what frequently actually didn't make that mistake. You know, So something occurred and in fact I did not anticipate it, but in retrospect, I didn't diticipate it. This is called hindsight. And that's one of the main reasons that we don't admit that we're wrong, is that whatever happens, we have a story. We can make a story, we can make sense of it. We think we understand it, and when we think we understand it, we alter our image of what we thought earlier. I'll give you a kind of example that so you have two teams that are about to play, you know, a football, and the two teams are about evenly balanced. Now one of them completely crushes the other. Now, after you have just seen that they're not equally strong, you perceive one of them as much stronger than the other, and that sception gives you the sense that you know, this must have been visible in advance, that one of them was much stronger than the other. So hindsight is that's a big deal. It allows us to keep a coherent view of the world. It blinds us to surprise us. It prevents us from learning the right thing. It allows us to learn the wrong thing. That is, whenever we're surprised by something, even if we do admit that we make a mistake. So oh, I'll never make that mistake again. But in fact, what you should learn, but you should learn when when you make a mistake because you did not anticipate something, that the world is difficult to anticipate. That's the correct lesson to learn from surprises that the world is surprising. It's not that my prediction is wrong. It's that predicting in general is almost as possible, you know. It's it's ironic. During the O eight oh nine finance shull crisis, we saw very few people beforehand making warnings about housing, about derivatives, about the stock markets. A pair of academics from Ryan Hart and Rogolf very famously put out a paper in January eight widely ignored afterwards. I can't tell you how many people have claimed to have seen it coming, never in print, there's no recorded history. But they all started coming and they knew this was going to go south. Pure hindsight. By this is really hindsight bias. It's actually very pernicious because it gives you the wrong impression. So I love Michael Lewis, and I like The Big Short like everybody, but The Big Short really gives you the impression that this was as obvious and the nose you know, see, when I read that book, my interpretation was here are a very small number of very odd characters who were amongst the only ones who saw it, and everybody else thought they were crazy. I mean, And the movie does a nice job portraying that. Yeah, but actually, at any one time, there are many people who are predicting that the world is going to end tomorrow, that there's going to be a crush next week. Now there is no crush. Those people get forgotten when there is a crash, the sort of geniuses. So we've seen that time and again, the broken clock syndrome. Eventually they're right everybody for although in the modern world, thanks to Google, you can very easily go back and check if someone has said there. There's a famous pundit who is for the past seven years, has been saying a seven like crash is around the corner. It's coming. Well maybe, but it's now seven years in a row. You've been saying, and there are many people you know, they're saying, is who predicted seven of the last three recessions? That's it's that's sort of So speaking of Michael Lewis, you and Amos Diversky are the subject of his next book that's coming out. Let's talk about that. What was that experience? Like Michael Lewis is a very lovable character and is very pleasant to talk to, and he earns your confidence by his charm and you know, he just he is very good at what he does. I haven't seen the book. I have no idea what it's what. I don't even want to see it before he gets published. You know, when it gets published, I'll read it, of course. But the process has been interesting because he's made me think about my past and that's been quite enjoyable. It has made me think about my my collaboration with a Mustwirsky. No I must Firsky died twenty years ago, and he is bringing him to life. And he also had access to all of Amos's papers, including notes that they must talk and conversations we have that's forgotten all about. So it's it's been an interesting experience reliving that period, but the experience would be about reading the book. I don't know yet. You can hang around a little bit. We'll keep we'll keep chatting. We've been speaking with Professor Danny Kahneman, winner of the two thousand and two Nobel Prize in Economics, former psychology professor at Princeton. If you've enjoyed this conversation, be sure and stick around for our podcast extras, where we keep the tape rolling and continue discussing all things biases and heuristics. Be sure and check out my daily column on Bloomberg dot com or follow me on Twitter at rit Halts. I'm Barry rit Halts. You've been listening to Masters in Business on Bloomberg Radio. Welcome to the podcast. By the way, it's so odd to call you Danny. Danny, if I haven't said thank you so much for being so generous with your time, let me do that now before before I um forget. I have been uh a big fan of your work for a long time and in my career I started as a trader and pretty early on recognized that why are these four guys doing the exact same thing and yet they're each obtaining very different results. And the first book on the in the space I read was by Tom Gilovich and Cornell, who I believe you've you've worked with before. Um, how we know it isn't so was was that book. But I've loved the work that you've put out, and I have a bazillion questions. Let's see if we can work our way through through some of these. So earlier on we were talking about anchoring and availability um. And one of the when I mentioned to a friend that you were an upcoming guest, the question he suggested is, well, the people who study biases and and the pitfall of human cognitions, they must be optimal decision makers, right, And I said, I'll ask so, well, certainly not, uh, you know. And the way that I described it, there's System one and their System two, and System one is very difficult to educate, and System one is where our intuitions come from. And system too, very often is just the pr agent four. System one it just explains decisions that were made, rationalizes, it rationalizes. But System one does a good job at keeping us alive and not only in the savannah, you know, keeping it keeps us alive. And most of the things that people do, uh are good. You know, I believe I'm to asky and I often considered sort of the profits of the irrationality. We don't never wanted that label. We don't believe that people are irrational. People are not perfectly irrational. They couldn't be, because they have the finite mind and perfect rationality demands much more. But you know, they're quite reasonable, except they make predictable biases in some mistakes in some conditions. So by and large, most people get many of their important decisions right, and the ones that get wrong really stand out. Well, uh, you know, it's hard to count. But most of the time, you know, most of the day you are on system one. You know, we're doing things that are well practiced, and most of them work. So we we managed to get through our day without engaging in without thinking too much, and well that for sure. Yeah, and most of the time it works just fine. That's that's quite so. The answer to your question was a long one, But no, I I'm not smarter than I was when I began this line of research more than fifty years ago. Because my system one is just the same way it was. I can recognize sometimes I can recognize situations in which I'm likely to make a mistake. So, h this person is trying to anchor me. Yeah, I can recognize that. It still works on me, by the way, but but I can recognize it. So well, let's let's talk a little bit about that. So I was always under the belief, apparently mistakenly, that if you become self enlightened about your own biases, then you can undertake a series of steps to prevent yourself from doing damage. We were speaking before the show started about indexing and global asset allocation. Now are you picking stocks and timing markets or have you taken your system too and allowed it to prevent system from saving I personally don't do anything of the kind you know, But I'm a conservative Poston and so there's nothing to be learned from the way that I handled my money. But I certainly I would not advise speaking individual stuff so or any form of very active manage. You strike me as a passive indexer who you specifically said, I don't want to check my portfolio too often people do that, and when they do, they tend to make mistakes. So this seems like a little closer to optimal decision making. You've identified a couple of biases that affect out people invest and you're engaging in the behavior to prevent yourself from Well, I'm mostly very lazy, you know. That's it. That's you can get to the same point by being rational or by being lazy. In that case, it's laziness. If that was true, I would have been a much better student in high school. Um so uh. Jason's ye of the Wall Street Journal is um was an editor with you on some work you did, and he said you you once said to him, and I want to get the quote exactly right. You have no sunk costs. So we're all familiar with the sun cost fallacy. How do you have no sun costs? I mean I have you know, it was in a particular context. It was in the context of how many drafts do you write? And I have no sun costs in the sense and the mere fact that I have written something, even if it's twenty or thirty pages. If now I decide it's not good, I don't try to fix it. I started over, throw it away and started over. That's that's having no sun costs. Now, the implication is some people would have said, Hey, I spent two hours on this, I'm gonna go back and edit this and try and make it. You're that that time and effort is spent as far as you're concerned. You're starting from scratch, and I think you do the things that way. If if you're if you forget about the work that you've already invested. But if you if you have found a better solution. Now instead of saying, oh, I should have written that chapter differently, you just rewrite that chapter differently. Now, don't Most people suffer from the some cost of fact They feel, well, I already spent this money, and now I'm committing. I bought this stock and now I'm kind of committed to it. You know, I've we're talking about writing, not not the decisions, but it's still it's still work process, it's still effort, and people tend to think, oh, I mean, most people are highly sensitive to some costs, and I would not say that I'm not in other domains of life. I said I'm free of some costs in the domain of writing. And that's what Jason Swag was writing about, because actually he thinks that most writers very reluctant, distilled over. Yes, absolutely, you put the time and effort in. Gee, I don't want to throw this away. I have something to work with. Um. It's always easier to do that that second draft than it is to start with a plane sheet of paper. No, no doubt about that. So we haven't really talked about the endowment effect. UM, But I have my favorite example that I wanted to share with you because I find this such a fascinating subject. Whenever. So I'm a car guy, and that means very often friends and family come and ask me about I'm thinking about this car or that car. What what's your view? And I've noticed it's a fascinating subject, like like the two football teams who are so evenly matched. When someone comes to you and says, I'm I'm considering these two cars. I'm thinking about the Toyota camera or the Honda Chord, and the camera has this, this and this, but the accord has that, that and that, and it's it's pretty evenly matched. And I'm I'm having a hard time making a decision. What's your opinion? And so I'll say, well, they're both great cars. You won't go wrong with either, but I think this one is a little nicer. What what do you think? I'll try and ask them some questions. Six months later, you see them and they bought car A over car B, and you asked them, how do you like the car? And the answer is, I can't imagine I was even considering that other car. This car is fantastic. Now nothing has changed. These are two really good automobiles, except for the fact that he now owns this car. So what is it about ownership that makes us think this is better, more valuable? Whatever? Why do we endow these these objects with with superiority. When you've owned something for six months, you think highly of it because it's become familiar, and almost everything that is familiar you like better. Really, So for smiliarity doesn't bring contempt. Familiarity makes you like things. So that's a that's a big psychological rule in general. Even in the study where I think it was a mug with the school's name on it, that's a different story. So that I said, when you own something for a long time, when you're discussing trading, then if you're not a professional, if you're an individual and you're thinking of a mug. Then you're not thinking of like thinking of wealth. You're not thinking of the state of the world in which you have that mugs against the state of the world in which you have seven dollars in addition to your wealth. You're thinking, if you have the mug, do I give it up? And if you don't have the mug, do I get it and give up the money for it? And giving up is more painful than gaining. And that's how loss a version gets involved in the endowment defect. It doesn't play any role in your story about the car because you're not about to trade the car, so you're liking for the car is more in effective familiarity and of something a psychological process that's called dissonance reduction. It chose that car, therefore it must be good. So that is true that almost anything that you chose becomes better because you chose it. But that's a different process than the endowment ef that's totally because it seems there's a big overlap between I chose it, therefore it's good, and I already own it and therefore it's valuable. Well, because you may own it without having chosen it. You know, I give you that mug and I ask would you sell it? So you just had it for thirty seconds and you you get the offer to sell it. So it's a different process. That's quite that. It's quite fascinating. Um. So I like this vote from thinking fast and slow. Our company comforting conviction that the world makes sense rests on a secure foundation of our almost unlimited ability to ignore our own ignorance. Explain that since you mentioned dissonance, I thought that was a good point to bring this up. Well. Earlier we talked about something I've read about in the book, which is what you see is all there is. And the idea that but you don't see is you know good refute everything that you believe. That just doesn't occur to us. So it's it's another way of telling the story. I was telling earlier that we construct the best possible narrative about the world, and if we're successful in constructing a good story, we believe it, we have a high confidence in it, and we don't want to change it. That makes perfect sense. Um Let's talk about regression to the mean and your conversation with the fighter pilot instructor who felt every time he yelled at a cadet they would do better and kind of ignored the fact that maybe it just happened to be did poorly and he was do to do well well the whole. You know, it's actually quite remarkable that the statistical fact that you know, it's as common as as the air we breathe is is very nonintuitive, and that's aggression to the mean. So the fact is that, you know, if you look at golfers, that's the example of developing the book. So you look at the three guys who scored the highest score yesterday, chances are they're going to do less well today. And that's I'll tell you why. It's because yesterday there's a sess was impowered due to luck, and luck is not going, not guaranteed to follow them today. So we have to think of regression to the mean that what we see has already luck built into it, and luck is not going to stay. So next time and next time it's likely to be less successful. You know, the golfer is likely to be less successful than he was because he's likely to be less lucky than he was. And people dramatically underestimating the impact of chance on their subsilently the separating skill from chance, especially in this field, is an ongoing battle, and very often what looks like very skillful managers turns out to be Hey, they were lucky for a couple of quarters. And and and now is that sure? And we have a very strong tendency, you know, everybody has that. We have that about ourselves, that we attribute our success our successes to our skill and failures, you know, to bad luck. But actually there is a lot of luck in our successes as well that we don't see that. That is uh an ongoing issue amongst investors and traders. Um it's it's always bad luck when the trade doesn't work out, But when it does work out, it's because I'm a genius, and we see that. We see that all the time. So, having read a lot of what you've written and over over a long time, I was surprised to learn that you don't describe yourself as particularly optimistic. And I thought that was kind of interesting because you've spent what more than a decade now looking at happiness and utility. Um, So the first question I have to ask is has studying this field made you any more optimistic or any any happier? No, I mean, you know, optimism is genetic anyway, and yeah largely, Uh you know, I'm the son of a very pessimistic mother, and so pessimism is sort of genetic too. I could see that is is it genetic or is it the home you were raised? Then no, I'm just I'm just pretty Actually it's actually genetic really so so so studying utility and studying happiness, what what conclusions have you reached based on that research? Well, the main conclusion was that there is a difference between what makes us satisfied and what makes us happy. So distinction because the distinction between the two. Being happy means having you know, having happy experiences and being satisfied is when you look at your life and what you've accomplished. Are you content and are you satisfied with what you've accomplished? And those two are really not the same, which is more important. Well, terms up that for most people what they try to do, if they try to be satisfied, they go for satisfaction and not for they are not thinking how can I maximize the quality of the my life? Mm hmm. So and many people, I think make big mistakes and that they settle themselves the big commute to have a larger home. You know, the big commute means an hour or two a day that are wasted. You know that counts. Time should count for a lot, because it's the only thing we've got basically, and people who waste time in order to achieve something else are wasting the part of their life. So so the studies I've seen is the longer your commute is, the less happy you are. Does that also lead to the less satisfied you? Not necessarily? Not necessarily, because if having a big home is part of your satisfaction, if you're sort of proud of the house you've got, uh, and you're paying for it by a long commute, you're not the way it's satisfied. Although you're not happy. You get a bigger house closer to your job, but it's going to be a lot more expensive. So so they're trading the time for that makes senseense. What what else have you what other things have you taken away from studying happiness and satisfaction? Well, you know, I think I think it turns out that people are happiest and when they're in the presence of friends, truly friends, and then you know there is a special thrill I think for people to be with friends, which is even more than to be with family. Really, why is that, Well, there's something more relaxing, and you know, when you're in a family, there are many obligations and many stresses, and so this is a pleasure that you sation being with friends. But those are some of the best moments of the week when you're not alone. There are there is a particular joy for many people in having shared routines with friends. You know, the weekly poker game, the weekly dinner and movie that that you share with friends. Over a period of years, that becomes very precious and it's you know, it's becomes an important part of life that that's really quite intriguing. Um. You know a lot of the discoveries we've talked about have the feeling to me of of epiphanies. So one of the things I specifically wanted to ask you about when you were doing the officer candidate evaluations for the Israeli Army um or when you uh would ask colleagues how long they thought it would take for for a project to be done. The results of these were just really wow, this is much different than everybody everybody believed. So what was it about your background and your training that let you look at the world so differently than everybody else around you. Obviously, these behaviors exist amongst everybody. What led you to these really fascinating discoveries that everyone else seems to have overlooked? Well, Uh, you know, I I I was born to be a psychologist. I really believe that, not my faith, but you know, the sort the thing was, I was better at that and at anything else. And I've always been interested in observing people and then trying to figure out, you know, why they are, where they feel, what they feel, and and so that's sort of curiosity about people I think as somehow paid afful me. So um um, so let's get to some of our favorite last few questions. I know we only have you here for a finite amount of time. These are the standard questions we ask all of our guests. Um. We we discussed uh, your your you knew right away you're going to be in academy or your whole career. Who were some of your early mentors? Well, I had professors. I had professors I loved when I was an undergraduates in Jerusalem. One in particular, I wouldn't call him a mentor, but you know, he was your sure life of it. It was his name. He was a hero to me and too many other people. Really why why is that? But what did he do that resonated with you so much? He just was a very powerful personality. He had strong opinions about everything. He knew a lot, he was, he had several doctorates, he was and he had a very individual character. So I loved he made a deep impression on me. In in graduate school, I had quite a few teachers, especially the one who supervised my thesis at Gizelli. But I learned from quite a few people when I was in graduate school. I don't think I ever had a proper mentor in the sense that that many graduate students today they get into a lab and they're associated with the same person throughout their career. In graduate school, that wasn't the case when I was in graduate school. You didn't belong to a lab and and so I didn't have that experience. So any previous psychologists or or clinical experimenters influence your approach to what you did or yeah, many, I mean mainly a man named Paul Meal, who who was the first to compare algorithms to clinical judgment and to reach the conclusion that algorithms are actually more accurate in many many cases than than intuitive judgment. Now I'm I'm I hope I'm not misremembering it. Um. Something you wrote specifically said, even after we show people the success ratio of the algorithms, they still wanted to stick with their their intuition. Yeah, that's absolutely true. I mean, people have people don't love algorithms, and and they better get used to them because they're taking over every right, this is happening. But you know, when you even think about that, when a doctor makes a mistake and the child dies, this is terrible, But if it was a piece of artificial intelligence that made a mistake and the child dies, that would be worse. At least today, because we trust the machinery, and the machinery it's more shocking. It's more shocking when it's impersonal. You know, when a self driving car has an accident, we just learned, we just learned about that, But there's something more shocking about the idea. So just think about that somebody dying in a in an accident, or somebody dying in an accident with a self driving car, and and that second idea is some more shocking, so people really don't for the time being, this is going to change. But there is such a thing. It's been called algorithmic version. Really, you know, when you look at the statistics, let's use the self driving car, by all measures, they're they're safer, they're more reliable, they're less likely to be involved in either a major or a minor accident. Doesn't mean you're gonna eliminate those sort of accidents. So when one happens, it seems to really resonate people. I mean, part of that is that there are things that a view does natural or as you know, sort of acts of God, and those we've learned to accept. But when it's acts of men, it's very different. So the best example is vaccines. So vaccines, you know, could cause sects side effect, they could Let's take a child who died from a vaccine. Now, how many children would the vaccine have to save to accept the death of one child from the vaccine. It's clearly not one to one. Now it's a lot of more millions, millions to I don't know. I hope it's not millions because that would be crazy. But but but it's a more than one. And so what what happens here is that anything that is man made we have a much stronger reaction to then than if the same thing occurs naturally. M that's quite fascinating. So so let's talk about books. What are some of your favorite books, be it fiction, nonfiction, Michael Lewis or otherwise. Well, in nonfiction, the best book I've read in in several years is called Sapiens. Sure, it's the short history of humankind. You've ash, well, Uh, I think it's superb. It's literally on my night table. It's the next book up in my queue. If you're telling me it's superb, I better started soon it twice? Really, I don't. Yeah, and there are many books. Wow, that's some endorsement. No, I think it's I think it's very impressive. So that's that was one. Uh, certainly in a seem Talib's book had a big effect on me, his last one, or Fooled by Randomness, mostly the Black Swan, but you know, I had liked fool by Randomness too, but the Black Swan I learned a lot from. And then obviously their works by by people I know like Nudge and Taylor. Taylor, I mean, so those are many of some of your favorites. Um, so you've mentioned you've been doing this for fifty years. What has changed in the field of psychology that really stands out to you over over that long period. You know, when I started my studies, a lot of psychology was still concerned with rats running mazes, and so the what it's called the cognitive revolution occurred during my career. Early in my career, so people sort of forgot, you know, just set rights aside, mostly except for physiological work. And when they wanted to study how the mind works, they studied how people think. So that that was a big change, and and there have been many other changes in recent years. Mostly it's the study of the brain that is taking over, and you know that's huge. The fm R eyes and that's you know this this came too late for me to be involved in, but if I had been younger, I would have done what younger colleagues of mine did and they switched. Is that going to be the biggest change going forward? Is the ability to pear into the brain while it's in operation. I'm convinced that that's the case for the next few decades, really a few decades Wow, that's that's amazing. All right. So we're up to our last two questions, our final two questions. If a millennial or a recent college grad came up to you and said, hey, I'm thinking about a career and in experimental psychology, what what sort of advice would you give them, whether to go into that or in something else or well, they said, I'm I'm considering this career. What advice do you have for me? What? What would your answer be? You must have had people students at Princeton ask you all the time. No, I mean I would ask what kind of psychologists you want to be? And I assure you want to be that kind of psychologist. And there are certain lines of studies, like going to graduate school. It's not for everybody, and some very very smart people who could succeed in graduate school should really not do it because there they will be happier doing something else than being an academic. An academic is is a life that's good for for a minority of people and for most others. You know, it's it's not great. So uh, I would never have ready made advice. It really depends on it really depends on the individual. And in our final question, what is it that you know about psychology and the human mind today that you wish you knew when you began fifty years ago. I can't think of that, actually, I mean it's very odd. You know, fifty years ago I didn't know many of the things I know today, and today I know a negligible amount compared to what people will know, you know, fifty years from now. Well, but you've also I don't I don't regret not knowing what I knew. I mean, discovering things and learning things has been so much fun that I have no regret about what they didn't know then. Um, maybe regrets the wrong word. What what would have been helpful to have known that you discovered later on in your career. I mean, there are there There are things that I learned even in recent years, in the last few years, which is there's a big change in psychology that that people are suspicious, and there is what it's called the reproducibility crisis. In sure that's across all sciences, and it's across all sciences that I wish I had been more careful about, in particular because I had thought about it, I had all the tools to see it and I was not sufficiently aware of it. Dr Danny Khaman, this has been absolutely fascinating. Thank you so much for being so generous with your time. If you have enjoyed this conversation, and be sure and look up an intro Down an Inch on Apple iTunes and you could see the other one hundred or so such conversations uh we've had over the past uh two years. I would be remiss if I did not thank my producers, Taylor Riggs and Charlie Valmer, Charlie also working as a recording engineer today, and of course our head of research, Michael Batnick, who has been a huge help in helping to prepare these questions. We love your comments and questions and suggestions. Be sure and send us an email. You can write me at b Ridholt's three at Bloomberg dot net. UM, you've been listening to Masters in Business on Bloomberg Radio.