What Happens When We Think We Know All There is To Know

Amar Pandit , CFA , CFP

In Professor Adam Grant’s book “Think Again”, I read an interesting story about an intelligent gentleman who got duped big time. While any of us can get duped in any area of life, there was something fascinating about this story.

“Imagine you have a family friend who’s a financial advisor, and he recommends investing in a retirement fund that isn’t in your employer’s plan. You have another friend, who’s knowledgeable about investing, and he tells you the fund is risky. What would you do?

When a man named Stephen Greenspan found himself in that situation, he decided to weigh his sceptical friend’s warning against the data available. His sister had been investing in the fund for several years, and she was pleased with the results. The financial advisor was enough of a believer that he had invested his own money in the fund. Armed with that information, Greenspan decided to go forward. He made a bold move, investing a substantial portion of his retirement savings in the fund. Before long, he learned that the fund had grown by 25 percent.

Then he lost it all overnight when the fund collapsed. It was the Ponzi scheme managed by Bernie Madoff.”

What made this story fascinating was that Stephen had written a book on why we get duped. Can you believe this – an expert writing a book on why we get duped gets duped himself? This is far more common than you think. There are certain mistakes that only an expert can make. Remember, knowing all the investor biases doesn’t necessarily protect you against them.

There exists a compelling irony in the world of finance and beyond: sometimes those most knowledgeable about a certain deceit are themselves susceptible to it. It’s a painful reminder that knowledge does not render us immune to trickery; rather, it may lull us into a false sense of security. The case of an expert on deception falling prey to Bernie Madoff’s Ponzi scheme epitomizes this paradox.

The Illusion of Infallibility:

We often believe that expertise in a field, acts as an armour against the very pitfalls that one studies. This belief is rooted in a cognitive bias known as the illusion of invulnerability” — the idea that understanding a flaw in others protects us from it. But this bias fails to account for the complexity of human psychology and the sophistication of certain deceptions.

Bernie Madoff and the Expert’s Fallacy:

Madoff’s scheme was one of the largest financial frauds in history, and it ensnared a wide range of investors, including those well-versed in the signs of financial deceit. The expert on dupery was, ironically, not immune. This isn’t just an anecdote; it’s a cautionary tale about overconfidence. When we consider ourselves impervious to the cons, we know so well, we may lower our guard at precisely the wrong moment. And the smarter you are, the harder it is to update your beliefs.

Why Even Experts Get Duped

  1. Overconfidence: Proficiency in a subject can lead to overestimating one’s ability to spot deception, causing experts to skip due diligence.
  1. Familiarity Bias: Experts might trust their network and fail to scrutinize the claims of a respected or familiar individual.
  1. Herd Behaviour: Even those who know better can be swayed by the collective confidence of other investors, particularly when those investors seem savvy or successful.
  1. The Halo Effect: The tendency to believe that because someone is successful or charismatic in one area, they must be trustworthy in another.

Adam added further, “Two decades ago my colleague Phil Tetlock discovered something peculiar. As we think and talk, we often slip into the mindsets of three different professions: preachers, prosecutors, and politicians. We go into preacher mode when our sacred beliefs are in jeopardy: we deliver sermons to protect and promote our ideals. We enter prosecutor mode when we recognize flaws in other people’s reasoning: we marshal arguments to prove them wrong and win our case. We shift into politician mode when we are seeking to win over an audience: we campaign and lobby for the approval of our constituents. The risk is that we become so wrapped up in preaching we are right, prosecuting others who are wrong, politicking for support that we don’t bother to rethink our own views.

 When Stephen Greenspan and his sister made the choice to invest with Bernie, all these three modes contributed to the ill-fated decision. When his sister told him about the money she and her friends had made, she was preaching about the merits of the fund. Her confidence led Greenspan to prosecute his friend who warned him against investing, deeming the friend guilty of knee-jerk cynicism. Greenspan was in politician mode when he let his desire for approval sway him toward a yes- the financial adviser was a family friend whom he liked and wanted to please.”

Investor Lessons:

  1. Remain Sceptical: Always perform due diligence, no matter how trustworthy the situation or individual seems.
  1. Diversify and Experiment: Avoid placing too much financial faith in any single investment. Experiment with smaller amounts.
  1. Seek Independent Verification: Look beyond the reputation and seek independent confirmation of claims.
  1. Acknowledge Limits: Understand and accept that no level of expertise can completely shield one from being deceived.
  1. Get the Care of a World Class Real Financial Professional: Partner with a top-tier real financial professional whose expertise and ethical standards are beyond reproach. They can provide tailored counsel, grounded in years of experience and a deep understanding of helping people like you to navigate the complexities of investing with confidence and peace of mind.

As investors, we must cultivate a balance between confidence in our knowledge and humility in the face of potential deceit. As the saying goes, “It’s the strong swimmer who most often drowns.” Expertise can help you navigate the waters of investment, but it is no substitute for the life jacket of professional guidance and care.

So, let this story be a lesson: knowledge is potential power, but even the most powerful must heed the signs of caution. We are quick to recognize when other people need to think again or rethink. But when it comes to our own knowledge, opinions, and beliefs, we often favour feeling right over actually being right. In the end, the true wisdom lies in knowing our real limitations and in the power of rethinking.