"Everyone is a genius in a bull market."
A breakdown on the dangerous Dunning-Kruger Effect:
A breakdown on the dangerous Dunning-Kruger Effect:
In an era when the markets have minted many new self-proclaimed geniuses, the Dunning-Kruger Effect is more relevant than ever.
This thread provides a breakdown of the famed cognitive bias, where we see it most frequently, and a few strategies for avoiding it...
This thread provides a breakdown of the famed cognitive bias, where we see it most frequently, and a few strategies for avoiding it...
First, a few definitions.
The Dunning-Kruger Effect is a cognitive bias in which people with low ability at a given task are prone to overestimate their ability at that task.
Put simply, humans are notoriously incapable of objective evaluation of their competency levels.
The Dunning-Kruger Effect is a cognitive bias in which people with low ability at a given task are prone to overestimate their ability at that task.
Put simply, humans are notoriously incapable of objective evaluation of their competency levels.
The cognitive bias was first identified by psychologists David Dunning and Justin Kruger in a 1999 study.
Their paper—entitled Unskilled and Unaware of It—summarized:
"People tend to hold overly favorable views of their abilities in many social and intellectual domains."
Their paper—entitled Unskilled and Unaware of It—summarized:
"People tend to hold overly favorable views of their abilities in many social and intellectual domains."
The two men had studied the bizarre case of McArthur Wheeler, a 5'6" 270lb bank robber who was swiftly caught after robbing two banks in broad daylight.
He hadn't worn a mask.
Instead, he had put lemon juice on his face, believing it would make him invisible to cameras.
He hadn't worn a mask.
Instead, he had put lemon juice on his face, believing it would make him invisible to cameras.
Wheeler was aware that lemon juice was used as invisible ink—so (incorrectly!) inferred that it could be used to make himself invisible to security cameras.
Even after he was caught, he was legitimately incredulous that his plan with the lemon juice hadn't worked.
Even after he was caught, he was legitimately incredulous that his plan with the lemon juice hadn't worked.
Dunning and Kruger studied whether the least skilled are the most overconfident.
Their finding: the worst performers consistently overestimated their abilities relative to others.
Let's look at a few examples of this bias in action and how you can avoid its pitfalls...
Their finding: the worst performers consistently overestimated their abilities relative to others.
Let's look at a few examples of this bias in action and how you can avoid its pitfalls...
Investing
As @mcuban says, "Everyone is a genius in a bull market."
When markets are ripping and your portfolio seems to grow by the day, many fall victim to the Dunning-Kruger Effect.
We may wrongly attribute this performance to our innate talent as investors.
As @mcuban says, "Everyone is a genius in a bull market."
When markets are ripping and your portfolio seems to grow by the day, many fall victim to the Dunning-Kruger Effect.
We may wrongly attribute this performance to our innate talent as investors.
Politics & Policy
With politics, intellectual humility is an aberration, not the norm.
Politicians espouse policy ideas with great confidence even if they have a weak handle of the details.
It's not shocking that we see Cobra Effects constantly in the policymaking realm...
With politics, intellectual humility is an aberration, not the norm.
Politicians espouse policy ideas with great confidence even if they have a weak handle of the details.
It's not shocking that we see Cobra Effects constantly in the policymaking realm...
https://twitter.com/sahilbloom/status/1398639354541641730
Business
Everyone has had that one boss—the know-it-all who actually knows very little.
These bosses and managers hold back organizations from high performance.
They are easy to spot—we all know who they are.
Beware this boss!
Everyone has had that one boss—the know-it-all who actually knows very little.
These bosses and managers hold back organizations from high performance.
They are easy to spot—we all know who they are.
Beware this boss!
But while we can all pile on against the investors, politicians, bosses, or public figures who seem to epitomize the Dunning-Kruger Effect, it is important to recognize that, as humans, we are all prone to this cognitive bias.
So how do we avoid it?
Here are a few strategies:
So how do we avoid it?
Here are a few strategies:
Identify your Circle of Competence
The Circle of Competence is the set of topic areas that align with a person's expertise.
Be ruthless in identifying and protecting the boundaries of your Circle of Competence.
Hint: it's usually smaller than you think.
The Circle of Competence is the set of topic areas that align with a person's expertise.
Be ruthless in identifying and protecting the boundaries of your Circle of Competence.
Hint: it's usually smaller than you think.
Get Comfortable With "I Don't Know"
Most people have an inherent discomfort with saying "I don't know."
Change that. Embrace what you don't know.
The world would be a much better, more efficient place if everyone were more willing to admit the gaps in their knowledge.
Most people have an inherent discomfort with saying "I don't know."
Change that. Embrace what you don't know.
The world would be a much better, more efficient place if everyone were more willing to admit the gaps in their knowledge.
Challenge Yourself
Consistently challenge your belief on your own competency ratings.
Do you actually know something as well as you think you do?
Do you truly understand it from a first principles perspective?
Can you explain it to a 5-year-old?
Be ruthlessly honest.
Consistently challenge your belief on your own competency ratings.
Do you actually know something as well as you think you do?
Do you truly understand it from a first principles perspective?
Can you explain it to a 5-year-old?
Be ruthlessly honest.
As Charlie Munger said, "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent."
Know your competencies, focus on them.
Know your incompetencies, avoid (or outsource) them.
Know your competencies, focus on them.
Know your incompetencies, avoid (or outsource) them.
The Dunning-Kruger Effect is dangerous.
"It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so."
So the next time you begin marveling at your skill at a task, remember what you just learned and the strategies for avoiding it…
"It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so."
So the next time you begin marveling at your skill at a task, remember what you just learned and the strategies for avoiding it…
Follow me @SahilBloom for more threads on business, finance, and decision-making.
I do deep-dives on these topics every single week in my newsletter. Join the 42,000+ others and subscribe today. sahilbloom.substack.com
I do deep-dives on these topics every single week in my newsletter. Join the 42,000+ others and subscribe today. sahilbloom.substack.com
And for more on the Dunning-Kruger Effect, I highly-recommend the sources below:
pubmed.ncbi.nlm.nih.gov/10626367/
forbes.com/sites/markmurp…
vox.com/science-and-he…
pubmed.ncbi.nlm.nih.gov/10626367/
forbes.com/sites/markmurp…
vox.com/science-and-he…
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