By Penelope Wang
December 6, 2016

Most people know Michael Lewis as the author behind such best-sellers as Moneyball, The Blind Side, and The Big Short, which focus on Wall Street or sports, or a combination of both. His latest, The Undoing Project, takes his storytelling in a different direction by focusing on two brilliant Israeli psychologists whose collaborative research into the quirky and irrational way our minds work radically changed economics and finance.

These two psychologists, Amos Tversky and Daniel Kahneman, were outsiders, very much in the mold of other Lewis underdog characters. But it was the power of their ideas and personalities, rather than a financial collapse or game win-loss records, that ultimately won over academic and industry critics.

Tversky passed away in 1996, but Kahneman went on to win a Nobel Prize in economic science in 2002. (If Tversky had lived, he would undoubtedly have shared the prize.) Kahneman continues to write and do research—his book, “Thinking Fast and Slow,” published in 2011, went on to become a best seller. Here’s what Lewis had to say about these unlikely academic pioneers.

Q: What can the average investor expect to learn from behavioral finance?

A: The broad lesson is you’ve got to get very good at watching yourself when making financial decisions. Your mind will mislead you. Tversky and Kahneman’s most well-known insight was identifying what’s called loss aversion. We care more about avoiding a loss than locking in a gain. They also identified the mental bias of representativiness—people look for characteristics that they think signal the qualities they’re looking for. For example, most CEOs are 6’2” white men. Is it because these people are really the best CEOs, or does being a tall white man give you an advantage at getting those jobs?

There are many other ways our minds create cognitive illusions. You’re susceptible to thinking what happened the last time will happen again. You’re susceptible to remembering winners and not losers. Our reluctance to part with stocks that are down, all that stuff. Some of the most interesting ideas were these throw-away thoughts, like Danny’s idea they played with for a while—how people making decisions aren’t actually trying to maximize their returns, but minimize regret. I see it all that time in people’s decisions.

Q: And how can we guard against these mental errors?

A: It’s not easy. We should all approach the market like card counters at a blackjack table, but we don’t. Both Danny and Amos became increasingly fatalistic about people’s ability to check themselves. It’s like when you see an optical illusion—even when someone points it out to youyou still see the optical illusion. That makes it hard to ignore.

But they were helpful in showing how you should approach decisions. They encouraged people to detach from yourself, to slow things down, and to create checks. Those ideas were put into practice back in the ’80s, when Delta Airlines asked Amos for help with a series of embarrassing mistakes—pilots were landing at the wrong airport. The problems were traced back to the pilots. Amos pointed out, you’ve got an autocrat in the cockpit who’s making decisions based on his own instincts, and no one is encouraged to question him. The solution was to train others in the cockpit share decision-making and question the pilot. The changes eliminated those mistakes.

Q: Does that mean we should rely on investing experts to guide our decisions?

A: It can, but I would say as a good rule, the more confident a financial advisor sounds, the more wary you should be. What you want is someone who is willing to explain to you that no one knows, that they’re operating in a volatile environment, with a lot of randomness to it.

If someone is telling you something like growth stocks are sure winners, you’ve got a really big problem. One of the great cons for bucket shop brokers is to send out recommendations on a stock—half are told sell and half to buy. If it goes up, call the folks you told to buy and say look I was right. They do that out a few more times, and you’ve got a handful people who were told the right thing three or four times in a row and they think you’re a magician.

The unknowability of elections, the price of stocks, the future performance of a professional athlete—these sorts of things are probabilistic matters at best and should be spoken of in those terms. Tversky and Kahneman are the kings of explaining why people don’t think probabilistically and the mind resists thinking the way it should it to solve the problems it faces.


Q: Will a Trump presidency make it easier or harder for investors to make good decisions?

A: There’s been really important work done to improve investor protections through behavioral research, including the design of choice architecture, such as 401(k) auto-enrollment. And the role of the Consumer Financial Protection Board to protect investors has been vital. It’s really disturbing to me that, in the wake of the 2008 financial crisis, we might roll back consumer financial protection under a new administration. It’s incredible to me to see a so-called populist movement floating these kinds of policy proposals and the people being hired, who have spoken against investor protections.

One way to tell the story of the financial crisis is as a result of bad incentives. Part of what Dodd-Frank was trying to do in a breathtakingly complicated way is to address some of those incentives. And amazingly, the financial sector wants to restore those bad incentives, such as allowing proprietary trading again. Once again, a heads I win and tails you lose proposition. The financial sector responds to incentives, and if you create an incentive to create a financial crisis, they’ll do it quickly and very efficiently.

I think we have real problem with anger already in this country—with the sense that there are people on the inside who gain all the advantages, and those on the outside who don’t. If you take away the remaining barriers that prevent elites on the inside from exploiting people on the outside, you’re going to create more anger. I didn’t think I’d ever have material about finance in my lifetime again that would be worthy of a book. I have a feeling the Trump administration is going to create it very quickly.


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