The Loss of Daniel Kahneman

By Ben Dolan

‍

One of my greatest joys as a parent is coaching grade-school basketball. The kids are new to the game, and I enjoy taking them through the fundamentals and watching them improve through the years. 

‍

At a recent end-of-year basketball team party, one of the other parents as me if I played growing up. This question always irks me. Why? Because of a few facts that immediately come to mind when asked that question: I wasn’t the best player on our team, my senior year we lost three times to our fiercest rival (including in the playoffs), and after my senior year I had zero interest from Division 1 basketball programs. 

‍

I’m an optimist by nature. And yet, when asked this question, I tend to think of the losses first and the many gains/positives second. For example, I may not have been the best overall player, but I was the best defender, the second leading scorer, and had interest from Division 2 and Division 3 schools to play ball. 

‍

So why is my immediate response (or at least my thought process) to the question not a bit more balanced? Why do I think of the negative first? And do investors do the same when they think about their financial gains and losses? I found the answer in the work of Psychologist, Daniel Kahneman (and his working partner Amos Tversky).

‍

Much of the research done by Kahneman and Tversky became the foundation of behavioral economics. Especially important was their work on Prospect Theory, or loss-aversion. Jason Zweig, writer of the Intelligent Investor column in the Wall Street Journal and a friend of Kahneman’s, in a piece on 4/8/24 following the passing of Kahneman on 3/27/24, describes the first time he heard Kahneman discuss loss-aversion at conference in 1996:

‍

“No, Danny said, money lost isn’t the same as money gained. Losses feel at least twice as painful as gains feel pleasant. He asked the conference attendees: If you’d lose $100 on a coin toss if it came up tails, how much would you have to win on heads before you’d take the bet? Most of us said $200 or more.”

‍

The fact that we feel investment losses so much more than gains can cause us to make bad investment decisions. For example, we might be too conservative with our portfolio allocation and outlive our investments, leaving us to rely on family and the government.

‍

Kahneman’s research suggests that, when picking investments, we tend to sell our winners too soon and hold our losers for too long. While we may think we are incorporating all available information into our decisions, that’s just not the case. Zweig continues: 

‍

“We think short streaks in a random process enable us to predict what comes next. We think jackpots happen more often than they do, making us overconfident. We think disasters are more common than they are making us suckers for schemes that purport to protect us…Noting that the stocks people sell outperform the ones they buy, Danny joked that ‘the cost of having an idea is 4%’”. 

‍

Thanks to Kahneman, I understand why I think of my basketball losses more than my gains, which helps me respond to questions with a more balanced approach. Taming the emotions that come with investing is part of how we help our clients avoid the big mistakes. By maintaining a long-term, strategic plan, we’re able to help see past the potential pain of loss and focus on the end goal.