The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he already knows, without a shadow of a doubt, what is laid before him. – Leo Tolstoy
|One of the painful things about our time is that those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.|
|—Bertrand Russell, The Triumph of Stupidity|
“Ignorance more frequently begets confidence than does knowledge.” – Charles Darwin, in The Descent of Man in 1871
|It is not in our human nature to imagine that we are wrong.|
The scourge of the finance MBA is that you become wedded to old ways of thinking which just may not be true given the evidence. The certain with what you think is true leads to a decision trap that cannot be exited.
The illusion of superiority and control is the key behavioral battle between discretionary and systematic investing. The discretionary manager will have the illusion of control and the overconfidence not to see changes in market structure or behavior. Smart people have a hard time admitting they are wrong. The systematic manager, when allowing for updating and adjustment, will adapt to changes in the market as factor sensitivities change. There is no ego involved with the adjustment of parameters. An optimization is not married to a way of thinking. It can be tied to minimizing errors.
Follow models with updates as new data become available and leave the overconfidence from what was learned in the past behind.