When we're in work, we all like to think we're good at our jobs, right? The idea that we have useful skills that can help us make big decisions is important to us. But what if those decision-making skills aren't as great as we think they are?
Such skills are especially important when that job involves trying to predict success. Say, you're a big-time movie producer and have to decide which film project will be a box-office hit, or a football manager who has to decide which player to buy to help win the league. The people that make these kind of decisions get paid a lot of money because they're good at it.
And it's the same with banking, isn't it? Bankers get paid well because they have the skills to decide which investments will be successful and make their clients lots of money. At least, that's the idea, right?
Well, take a look at the following video...
So, if it's all really just luck and nothing to do with skill, why do people keep investing, and why do bankers keep trying to beat the market?
Take a look at this...
So it's to do with what the average is. Essentially, sometimes you'll win, sometimes you'll lose. In the long run it doesn't really matter. But after all that work, all that analysis, all the experience you have, surely that counts for something? Surely the skills you have are real?
So we tend to interpret any luck we might have as being the result of the skills we possess. If we predict something and get it right, and this happens a few times, we're more inclined to believe in our ability to predict future outcomes, despite the fact that the evidence suggests it's all just chance in the end. The phenomenon is know as 'the illusion of skill'.
The Nobel Prize-winning psychologist Daniel Kahneman describes the illusion of skill as being "deeply ingrained in the culture of the [finance] industry. Facts that challenge such basic assumptions – and thereby threaten people’s livelihood and self-esteem – are simply not absorbed."
In fact, when he computed the persistence of skill of 25 fund managers at an investment firm, he concluded that “The results resembled what you would expect from a dice-rolling contest, not a game of skill.”
So when making investments, it seems the important thing is sticking to the belief that your personal skill at making decisions has directly affected the outcome. That way, it's possible to justify your high-paid job, despite what the evidence seems to suggest!