Notes
Paul Wilmott researcher
Annualize monthly returns
Expected return
Beta, the risk-free rate, and CAPM. Calculate the expected return of a security on Excel. https://www.youtube.com/watch?v=rPY2wGyOtGM
3 Lessons and an Action Plan Your brain has two personalities or thinking modes. One’s impulsive, emotional, and automatic; the other is slow, logical, and deliberate. Guess which one makes most of your decisions? In Thinking, Fast and Slow, Daniel Kahneman argues that though we think of ourselves as rational creatures, we’re largely driven by irrational cognitive biases—subconscious patterns of thought that control how we think, feel, and behave. In this Mini Book Guide, we’ll outline the basics of Kahneman’s insights on how mental shortcuts affect your choices and how you can think clearly despite them. For a deeper summary, check out our complete guide.
Lesson 1: Mental Shortcuts Can Lead to Errors Mental shortcuts form our automatic System 1 thinking, which allows us to quickly evaluate situations by recognizing patterns and cues we’ve seen before. This contrasts with deliberate System 2 thinking, where we take our time and carefully consider all angles of a problem. System 1 makes us more efficient, but it can also lead to errors in judgment—the cognitive biases Kahneman refers to.
Lesson 2: Biases Affect How We Understand the World Biases color our beliefs about everything from religion to politics to the economy. Some biases impacting our views include:
Confirmation bias: We pay attention to data that confirms what we already believe, and we ignore data that contradicts it. Availability bias: We pay more attention to things that come easily to mind—thus, we fear plane crashes more than car accidents, even though car accidents are more likely. Narrative bias: We like stories, so we see connections in random data that don’t actually exist.
Lesson 3: Biases Influence How We Make Decisions Biases can also push us to act in certain ways:
Loss aversion bias: We feel the pain of losses more intensely than the joy of gains, leading us to hold on to bad investments or resist change even when it’s rational to adapt. Anchoring bias: We judge the value of something based on other numbers that are suggested. We’ll pay more for an item if we’ve heard other high numbers recently, even if those other numbers aren’t related to our purchase.
(Shortform note: In Nudge, Richard Thaler and Cass Sunstein argue that lawmakers should design public policy to take advantage of people’s biases—since biases will drive people’s behavior anyway, why not leverage them to nudge people to make good decisions rather than bad ones? Thaler and Sunstein call this libertarianism paternalism, combining an individual’s freedom to choose with guidance and oversight.)
Lesson 3: Biases Influence How We Make Decisions Biases can also push us to act in certain ways:
Loss aversion bias: We feel the pain of losses more intensely than the joy of gains, leading us to hold on to bad investments or resist change even when it’s rational to adapt. Anchoring bias: We judge the value of something based on other numbers that are suggested. We’ll pay more for an item if we’ve heard other high numbers recently, even if those other numbers aren’t related to our purchase.
(Shortform note: In Nudge, Richard Thaler and Cass Sunstein argue that lawmakers should design public policy to take advantage of people’s biases—since biases will drive people’s behavior anyway, why not leverage them to nudge people to make good decisions rather than bad ones? Thaler and Sunstein call this libertarianism paternalism, combining an individual’s freedom to choose with guidance and oversight.)
Action Plan To prevent your biases from leading to poor decisions, shift to deliberate System 2 thinking. Kahneman recommends that you:
Slow down: Pause to quell your knee-jerk reactions. Challenge your assumptions: Question your first impression. Ask yourself what you might be missing. Think about how someone who disagrees with you might see the problem. Be aware of framing: Notice how questions are phrased to spot potential manipulation toward a particular answer. For example, does a question emphasize a potential loss rather than a potential benefit?
