Uncovering the illusion of skill behind an expert's "magic"
How many times have you turned on the financial channel and heard the experts screaming “buy this, sell that, market is up, market is down...”. Often, we form our views of the world by relying solely on the opinions of experts. They can be found in any field, not just finance.
Essentially, I want to challenge the notion of trusting expert advice, do they possess some type of "magic" none of us possess? Are they capable of making better decisions than we are? How well can they perform compared to the average person?
When taking advice from an expert, there are several things we should keep in mind. They are often overconfident in their abilities. As a result, they may make poor decisions because they believe they know more than others do. Furthermore, experts may be biased in their opinions, which can lead to inaccurate advice.
To prepare you for making difficult and important decisions in life, I intend to reveal the truth about the situation. There is a phenomenon known as the illusion of skill.
The illusion of skill is the belief that one is more accurate in predicting future events than is actually the case. This phenomenon is often based on overconfidence in one's own abilities. As a result, they may take unnecessary risks, make suboptimal decisions, and in general fail to achieve their full potential.
The illusion of skill is maintained as long as successful forecasts create the impression that they were based on something more than a random chance. If the stock picker for example is lucky and makes a string of right decisions, people will perceive him as a skilled investor; if he is unlucky and makes a series of wrong decisions, they will see him as unskilled. If we see a student getting high grades, we assume that she must be smart; if we see a company doing well, we think it must have good management.
This is an example of the representativeness heuristic, which is when people use stereotypes and previous experience to make judgments about new situations.
I find it interesting that even if we show the management information that their brokers' stock selections are just random chance, they will not believe you and may even blame you for challenging their beliefs.
Why does that happen, you wonder?
A new piece of evidence can force us to change our beliefs, but doing so means admitting we were wrong or just lucky. This is difficult for us to do, because it can be embarrassing and even humiliating. It can also be costly, both financially and emotionally. Therefore, we often cling to our existing beliefs, even when they are no longer accurate. In addition, we cannot admit that we are lucky, because doing so would undermine our confidence.
Imagine a NYC stock broker driving his Porsche, wearing a three piece suit and smoking a cigar, when a teenage boy wearing bit up sneakers approaches him and shows him the following.
In a fifty-year study that was carried out by the best universities and researchers around the globe, it was proven that no forecaster can accurately predict the price of the stock and that if a kid flips a coin, his results will resemble those of the broker. Would you admit that your skill is basically a mirage? Again, I have nothing to do with stock brokers, I just want to drive the point home. The problem isn't them, it's us. Since we believe that these people have some sort of magic, we give them our valuable savings so that they can play with them all day.
To summarize, there are a number of things we can do to improve our predictive accuracy.
Rather than blindly relying on experts, you should keep in mind that their success is more of a function of luck than talent or skill. According to a study by Philip Tetlock, experts were only slightly better at predicting the future than chance.
Take into account the possibility that some factors may improve or worsen over time. It was widely believed during the 1970s that oil would not last. Nevertheless, no one could have predicted more efficient turbo engineers and the global move toward green energy.
In addition, we can ensure that our predictions are backed up by solid logic and evidence. Gather as much accurate information as you can. A good example of this would be the World Economic Forum - weforum.org
It is important to remember that our predictions may be wrong, and that we should be prepared to change them if new information becomes available. Last but not least, don't assume what happened yesterday will happen today.