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BASEBALL USED TO BE a game where managers would go with their “gut.” But Brad Pitt changed everything. In the movie Moneyball, Pitt played Billy Beane, the first baseball general manager to use data analytics to great success—and suddenly it was all the rage.
Today, from a typical game, seven terabytes of data are gathered, everything from the arm angle of every single pitch to the exit velocity of hit balls. Teams then interpret these numbers using sophisticated algorithms, so managers have the insights necessary to make decisions based on statistical probabilities rather than intuition. Big data analytics now drive baseball decisions on and off the field—because the process has proven to work.
The traditionalist in me revolts at this dehumanization of baseball. But the investor in me sees an opportunity to learn from baseball’s experience. I see two key lessons.
Lesson No. 1: Be aware of cognitive biases—especially the Dunning-Kruger effect. What’s that? People who are the most ignorant about a topic tend to be the least aware of their ignorance and, as a result, often have the highest confidence. Bad things usually happen when we suffer from overconfidence.
We can see evidence of this bias in the rising number of day traders. New apps have made it easy and fun to trade stocks and options. With the market hitting all-time highs, new traders have—I suspect—been lulled into thinking investing is easy.
The media feeds into this belief. We’re bombarded with headlines like “8 Stocks to Buy and 5 to Sell,” making successful investing seem as simple as reading a monthly investment magazine.
I learned about investing by watching the popular PBS show Wall Street Week with Louis Rukeyser. The highlight of the show came at the end of the year, when the stock pickers would wear tuxedos and be either exalted or humiliated based on how their stock picks had performed that year. They would then confidently offer stocks for the next year, persuasively explaining why the new picks would be winners.
It was great theater but misleading for a novice like me. At the time, it never occurred ro me that, in any given year, random luck was possibly the biggest factor in determining which stock pickers did best.
Instead, for me, the moment of clarity came in an investment course I took during an MBA program. As I dug into the complex math of securities analysis, it dawned on me that there would always be investment analysts much smarter than me. I might get lucky now and again, but it was unlikely I would ever gain a true long-term competitive edge in investing, no matter how hard I worked. It was during that class that I found humility. I was not going to be the next Warren Buffett.
Lesson No. 2 comes from poker. Good poker players develop a process that puts the probabilities in their favor. They don’t panic about short-term losses but instead stay committed to their winning strategy. In fact, poker players expect to lose often, but it doesn’t shake the confidence of the good ones. If they’ve done the math correctly, they know the odds of eventual success are in their favor.
Modern baseball and poker players both recognize that patterns exist in games that they can exploit—provided they eliminate cognitive biases and stick to high probability strategies. As small investors, we may not have access to supercomputers to crunch big data, and we may not have the ability to count cards and mentally calculate the odds of success while sitting at the poker table. Still, we can garner sufficient understanding of such things to improve our chances of investment success. To that end, here are four suggestions:
Joe Kesler is the author of Smart Money with Purpose and the founder of a website with the same name, which is where a version of this article first appeared. He spent 40 years in community banking, assisting small businesses and consumers. Joe served as chief executive of banks in Illinois and Montana. He currently lives with his wife in Missoula, Montana, spending his time writing on personal finance, serving on two bank boards and hiking in the Rocky Mountains. Check out Joe’s previous articles.
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Dear Mr. Kesler,
I just spent hours researching the D-K effect(Lesson 1). Thank-you. I forwarded the info on the D-K effect to several email pals.
Louis Rukeyser, CNBC, Real Money.com were my go-to’s in 1999-2002. My disastrous “investing” resulted. I had to start from scratch in 2002 by learning more from articles on the internet. Now I’ve come full circle and hired a fiduciary in my retirement that has a similar stance to my own. There is so much I don’t know about things like taxes and such. There’s also a lot I’m 95% sure about that is actually probably only 5% true.
Entertaining read! Thanks for introducing me to the Dunning-Kruger effect. I wasn’t aware of my ignorance and was totally confident that nothing like that existed:)
No snark intended. Just a lame attempt at humor.
I see what you did there…
Ha! Thanks Bob for the comment..snarky or not!