Jul 7, 2017

Book Recommendation- Thinking Fast & Slow- Daniel Kahneman

Daniel Kahneman is a Nobel laureate in Economics. He is considered as one of the founding fathers of the field of Behavioural Economics (where psychology and economics intersect) which is today the leading research area within economics itself. 
Many specialised departments have been created in the leading universities of the world to build on the insights of Kahneman and others who've followed him. His work has had a tremendous impact on government, policy, education and even investing. 
In the book Thinking Fast & Slow Kahneman explores the concept that the brain uses two modes of thinking. I'll explain this briefly below. 
Can you multiply 7*3? Doing this in school repeatedly the answer "21" comes immediately to mind. Now try 38*24. Now this is a little harder. Requires us to pause a moment and apply ourselves. Most of us would require pen and paper to solve this.
The first question is an example of what Kahneman calls System 1 thinking. It is intuitive and comes to us almost effortlessly. The second question is an example of System 2 thinking. It requires some application.
Now, we mostly operate in the world using System 1. i.e we make some prior assumptions of the world and rely on our intuitions to help us take decisions. This system works for us "most of the time." However, in an increasingly complex world we find that sometimes relying on intuition can have disastrous consequences.
The brain is the organ that consumes the most energy in the body. The brain typically prefers System 1 responses. This is because it requires less effort (energy) and is probably an evolutionary measure to 'conserve energy'. When faced with a tough task (or a pressing question) we often experience a loss of ability to process other tasks. This is because our System 1 is sort of facing an over-load. It is not able to process the data that is being thrown at it. This is typically when we experience 'stress'. The brain doesn't like 'stress' and often resorts to quick impulsive decisions to "ease the load". 
Thoughtful questions require us to use System 2. System 2 doesn't operate when the mind considers it impertinent to arrive at a quick conclusion to a pressing problem. System 2 is the more logical side of the brain. We often need to de-clutter ourselves (our minds) in order to experience System 2. This is a useful insight.
This book is a wonderful read and I recommend it to anyone who is interested in "thinking about thinking".

Jun 24, 2017

Weekend Reading- The Man who Drowned

There is a story of a man who wanted to cross a river that had a depth of “four feet on average.” Feeling fairly confident about it he set about on his journey only to drown somewhere near the centre.

Beware of the ‘averages’!

In his brilliant little book- “How to Lie with Statistics”, Darell Huff introduces us to this particular concept and how the human mind gets lulled in to understanding the term ‘average’.

Think about it like this. Suppose you were building data on incomes of all your neighbours. If we took an average then it is possible that with some accuracy we could tell you what each person was earning. But what if one of your neighbours was Mukesh Ambani? Wouldn’t the average income number be way off the mark?

Finding exceptions in your Data Set

A sense of confirmation bias (covered earlier) and an inability to conceptualize a black swan (like having Mukesh Ambani as your neighbour) can create problems for us like the man who drowned. It is therefore imperative for us to:

1. Understand the sample set of data that we are reading and 
2. Actively look for exceptions to the rule.

How does this play out in your finances?

“Equity markets have returned 15% on average over the long-term.”

“Real-estate will beat inflation on average.”

“My salary will increase at 10% per year since that has been the past average.”

Can you see exceptions to all those cases? What can cause them? Are you at the crest or trough of your sample space? Each of these can have wide-leading ramifications to the way you ‘plan’.