well, I took it away from you

In 1984, Amos and I and our friend Richard Thaler visited a Wall Street
firm. Our host, a senior investment manager, had invited us to discuss the
role of judgment biases in investing. I knew so little about finance that I did
not even know what to ask him, but I remember one exchange. “When you
sell a stock,” I asked, “who buys it?” He answered with a wave in the
vague direction of the window, indicating that he expected the buyer to be
someone else very much like him. That was odd: What made one person
buy and the other sell? What did the sellers think they knew that the buyers
did not?

Since then, my questions about the stock market have hardened into a
larger puzzle: a major industry appears to be built largely on an illusion of
skill. Billions of shares are traded every day, with many people buying
each stock and others selling it to them. It is not unusual for more than 100
million shares of a single stock to change hands in one day. Most of the
buyers and sellers know that they have the same information; they
exchange the stocks primarily because they have different opinions. The
buyers think the price is too low and likely to rise, while the sellers think the
price is high and likely to drop. The puzzle is why buyers and sellers alike
think that the current price is wrong. What makes them believe they know
more about what the price should be than the market does? For most of
them, that belief is an illusion.
(...)

Mutual funds are run by highly experienced and hardworking
professionals who buy and sell stocks to achieve the best possible results
for their clients. Nevertheless, the evidence from more than fifty years of
research is conclusive: for a large majority of fund managers, the selection
of stocks is more like rolling dice than like playing poker. Typically at least
two out of every three mutual funds underperform the overall market in any
given year.

More important, the year-to-year correlation between the outcomes of
mutual funds is very small, barely higher than zero. The successful funds in
any given year are mostly lucky; they have a good roll of the dice. There is
general agreement among researchers that nearly all stock pickers,
whether they know it or not—and few of them do—are playing a game of
chance. The subjective experience of traders is that they are making
sensible educated guesses in a situation of great uncertainty. In highly
efficient markets, however, educated guesses are no more accurate than
blind guesses.

Some years ago I had an unusual opportunity to examine the illusion of
financial skill up close. I had been invited to speak to a group of investment
advisers in a firm that provided financial advice and other services to very
wealthy clients. I asked for some data to prepare my presentation and was
granted a small treasure: a spreadsheet summarizing the investment
outcomes of some twenty-five anonymous wealth advisers, for each of
eight consecutive years. Each adviser’s scoof re for each year was his
(most of them were men) main determinant of his year-end bonus. It was a
simple matter to rank the advisers by their performance in each year and
to determine whether there were persistent differences in skill among them
and whether the same advisers consistently achieved better returns for
their clients year after year.

To answer the question, I computed correlation coefficients between the
rankings in each pair of years: year 1 with year 2, year 1 with year 3, and
so on up through year 7 with year 8. That yielded 28 correlation
coefficients, one for each pair of years. I knew the theory and was
prepared to find weak evidence of persistence of skill. Still, I was surprised
to find that the average of the 28 correlations was .01. In other words, zero.
The consistent correlations that would indicate differences in skill were not
to be found. The results resembled what you would expect from a dicerolling
contest, not a game of skill.
(...)
Our message to the executives was that, at least when it came to
building portfolios, the firm was rewarding luck as if it were skill. This
should have been shocking news to them, but it was not. There was no
sign that they disbelieved us. How could they? After all, we had analyzed
their own results, and they were sophisticated enough to see the
implications, which we politely refrained from spelling out. We all went on
calmly with our dinner, and I have no doubt that both our findings and their
implications were quickly swept under the rug and that life in the firm went
on just as before. The illusion of skill is not only an individual aberration; it
is deeply ingrained in the culture of the industry. Facts that challenge such
basic assumptions—and thereby threaten people’s livelihood and selfesteem—
are simply not absorbed. The mind does not digest them. This is
particularly true of statistical studies of performance, which provide baserate
information that people generally ignore when it clashes with their
personal impressions from experience.

The next morning, we reported the findings to the advisers, and their
response was equally bland. Their own experience of exercising careful
judgment on complex problems was far more compelling to them than an
obscure statistical fact. When we were done, one of the executives I had
dined with the previous evening drove me to the airport. He told me, with a
trace of defensiveness, “I have done very well for the firm and no one can
take that away from me.” I smiled and said nothing. But I thought, “Well, I
took it away from you this morning. If your success was due mostly to
chance, how much credit are you entitled to take for it?”

Thinking Fast and Slow, Daniel Kahneman, prémio Nobel da Economia