Fellow investors,

What's the best way to get better investment returns?

Should you study markets more deeply and analyze every asset more carefully? Should you try to anticipate other people's mistakes and exploit their stupidity?

I believe that's necessary, but not sufficient.

You must also try to predict, minimize and learn from your mistakes. Blindness to our own blunders is the biggest single obstacle to investing success.

Many people think of behavioral economics as the study of the flaws and pitfalls of the human mind, a window onto the world of other people's foolish behavior.

I see it differently. Instead of viewing behavioral economics as a window, we should regard it as a mirror.

I learned this from Daniel Kahneman, the psychologist who died late last month. He and his research partner, Amos Tversky (who died in 1996), pinpointed the inconsistencies and incoherence in other people's thinking by studying their own.

Kahneman and Tversky held up a mirror to themselves -- and to the human mind.

The image that emerged was nothing like the model that conventional economists had long believed in.

Instead of relying on all available information, we jump to sweeping conclusions from fragmentary data. We think vivid events are more frequent than they are. We overestimate our own experience and expertise. We anchor on irrelevant numbers, exaggerate our successes and forget our failures.

Like you, I bet, I've always found it painful to admit I'm wrong. Do you hate to think about your mistakes, past, present and future?

That makes us normal human beings. But we can do better -- and become better.

Kahneman and Tversky loved thinking about their own errors.

From the first day the two men began working together in 1969, “they were exhilarated,” recalls Barbara Tversky, Amos’s widow. “That merging of minds and interests was phenomenal. It was a unique privilege to hear their joy, to watch that work unfold and to see that deep friendship develop.”

I met Kahneman in 1996 and later spent two thrilling and sometimes agonizing years helping him write his bestselling book, Thinking, Fast and Slow. He showed me the vital importance, as an investor and a person, of changing your mind and admitting when you're wrong.

Self-reflection is pointless unless the person in the mirror is you: not the person you wish you were, but the flawed and fallible person you are.

Once Danny taught me how unreliable the human mind is, I came to believe that everything in investing that can be done with rules, policies and procedures should be.

Instead of trying to guess when to invest how much in what, take your emotions out of the equation: Use dollar-cost averaging to invest a fixed amount every month.

Instead of buying based on your gut feelings or other people’s hunches, use a checklist that permits you to buy only if the asset meets a set of objective standards. Keep records of all your forecasts, so you can’t lie to yourself.

Track the returns of the assets you sold, as well as those you hold, to learn if you’re any good at trading. Always count your gains and losses not in isolation, but in proportion to your total assets.

All these ideas flow from Kahneman and Tversky’s work.

What do you think is your greatest weakness as an investor, and how have you sought to overcome or counteract it?

To share your thoughts, just reply to this email. Responses may be edited for brevity or clarity. Please include your name and location.

The day in 2006 that Danny and I started working in earnest on Thinking, Fast and Slow, he began by asking: How long would it take us?

He shaped my answer by retelling me one of his favorite stories, about a textbook that took forever to finish. Then he showed me how to take what he called “the outside view,” rooted in base rates: the historical evidence of other people’s success in similar situations.

He asked a string of questions: How many books similar to this can you think of? How long did they take to finish? How many similar books got abandoned and were never published? How many words can you write on a good day? On a bad day? How many days are likely to be good or bad?

This took hours. It wasn’t easy to uncover details about ambitious books that never saw the light of day -- or to be honest about our own limitations as writers.

Finally, we decided that the book might take as little as a year (there were two of us, after all!) and as much as two-and-a-half.

Thinking, Fast and Slow was published late in 2011, almost five years later.

Early in his career, Danny had spent countless hours measuring the precise, moment-to-moment changes in the diameter of the pupils of people’s eyes. He brought the same precision to bear on words and ideas.

In the spacious living room of his New York apartment, we edited the book by reading alternating paragraphs aloud to each other. Every sentence or two, Danny would stop and ask me: “What did you mean by that?” or, even more often, “Now what do we think I mean by that?”

Every few days, often every few hours, sometimes every few minutes, Danny would threaten to quit. Somehow, I kept talking him out of it.

Often, I would wake up, open my email, and find a barrage of messages he had sent in the middle of the night, beginning with doubt, moving through self-flagellation toward despair -- then culminating in a complete transformation.

“It is obvious that we are on a road to nowhere,” he emailed me at 1:49 a.m. on April 21, 2007. “We need to make drastic changes in the way we work, because we are failing,” he emailed two minutes later. “There is still hope, but we need to reorganize.”

At 3:26 a.m., he emailed: “One thing I can probably do is construct a list of the basic ideas that a chapter contains.”

He ended up rewriting the entire chapter from scratch. At 9:57 p.m., he emailed, “I am making progress on my duties.”

“This is fixable,” Danny emailed me at 1:23 a.m. on Aug. 28, 2007, under the subject line “back to you.” At 1:43 a.m he said, “[your] tough evaluation was appropriate.” At 2:41 p.m., “I send you this with some trepidation,” he wrote. (I don't know when, or whether, he slept.)

In fact, he had completely rewritten what ended up as chapter four of Thinking, Fast and Slow. This latest draft, which he had changed utterly from the previous version, still retained a trace of Danny’s eternal dissatisfaction: “THE NEXT SENTENCE IS VERY UGLY.”

After another relentless round of rewriting, it no longer was.

Every investor could use a bit of that self-doubt that drove Danny never to accept anything on faith and always to believe that good enough is terrible.

Be well and invest well,

Jason

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If owning stocks is a long-term project for you, following their changes constantly is a very, very bad idea. It’s the worst possible thing you can do, because people are so sensitive to short-term losses. If you count your money every day, you’ll be miserable.
—Daniel Kahneman