The Limits of Our Knowledge: Why Only a Few Know How to Avoid Bad Decisions

It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.

— Amos Tversky

Awareness of the limited extend of your knowledge is an essential component in decision making, yet it’s easily missed. Black Swans like the 2008 housing market crash and the Coronavirus pandemic have made it even more obvious just how little we know about the future.

Not only is it hard to know what the future holds most of the time, it is also true that very few people posses superior knowledge on these matters that can be regularly turned into a business advantage. Instead what we get are a lot of cocksure analysts, journalists, pundits, and forecasters who claim to know more than they really know. Truth is, they don’t know what they don’t know.

While, it’s possible to have better know-how than the next person about a particular technology, trend, domain, or company with enough hard work and focus, it’s very less likely to be the same in case of the market or the economy. If I ask you, of all the economists, strategists, journalists, and professional analysts that you see on the news or follow on Twitter, if there’s anyone who consistently predicts what lies ahead, you would most likely say no. Irregular forecasters are unreliable.

A prediction of global crisis in 2007– 2008 would have had great potential value. But if you saw that it came from someone who wasn’t right consistently—and someone with a visible negative bias—would you have acted? That’s the trouble with inconsistent forecasters: not that they’re never right, but that the record isn’t positive enough to inspire action on their occasional brainstorms.

— Howard Marks, The Most Important Thing

Also, forecasters aren’t necessarily doers. They are mere entertainers whose job is to keep the viewers engaged, and give us a false sense of command over our future. It’s sad that a lot of us are gullible enough to take investment advice from them. You see, there’s a difference between a charlatan and a doer. Unlike them entertainers, you won’t see someone like Warren Buffett or Rakesh Jhunjhunwala sitting and predicting the market. They neither have the time nor the intention. They are just too busy doing instead of, what Nassim Taleb calls, “tawking”.

On top of that, it is highly doubtful if the forecasters bet on their own forecasts ever. Words and forecasts both come cheap. Unless somebody is ready to put their neck on the line, don’t take their advice, no matter how “helpful” they sound. As Nassim Nicholas Taleb remarks in his famous book Skin in the Game:

“There is a difference between a charlatan and a genuinely skilled member of society, say that between a macrobull***ter political “scientist” and a plumber, or between a journalist and a mafia made man. The doer wins by doing, not convincing. Entire fields (say economics and other social sciences) become themselves charlatanic because of the absence of skin in the game connecting them back to earth (while the participants argue about “science”).”

Almost all “expert” forecasts are mere extrapolations of past experience. Ironically, they are of little value even when they are correct, because just like expert forecasters, the market also assumes the price to be a continuation of recent history. Thus if the future turns out to be more or less like the past, it doesn’t really make any difference.

What really matters isn’t being right all the time, but how much you make when you are right. The outcome is more important that the forecast itself. If your forecast says nothing changes tomorrow, it practically has no value even if you are right. Your forecast is as good as the outcome. Nassim Taleb comes to rescue again.

“I personally know rich horrible forecasters and poor “good” forecasters. Because what matters in life isn’t how frequently one is “right” about outcomes, but how much one makes when one is right. Being wrong, when it is not costly, doesn’t count—in a way that’s similar to trial-and-error mechanisms of research.”

In conclusion, policymakers, journos, strategists rarely know what they are talking about. They don’t know the limits of their own knowledge, and perhaps have too much faith in their own predictions. It would be foolish if you listen to them blindly. It would also be foolish if you aren’t sceptical about your own predictions. Unless you can argue better than your opponents, you haven’t done the work required to have an opinion about the future.

But let’s accept it, no one likes to invest in a future that is largely unknowable. We all wish to have some command over it. But we often commit a carnal sin in probabilistic decision making when we forget about the difference between probability and outcome—when we assume that the most likely outcome is the one that will happen; that the expected result is the actual result.

Back in 2005-07, a lot of people overestimated the extent to which outcomes were knowable and controllable. They underestimated the risk present in the things they were doing. They ignored the limits of their own knowledge, and we all know what followed.

Truth is, probability doesn’t come naturally to us. We chronically ignore the possibility of improbable outcomes. We are very less likely to learn from others’ mistakes and underestimate the limits of our own knowledge. Overconfidence often gives way to reason and healthy scepticism, and that’s precisely why very few among us can avoid wrong decisions consistently. Having said that, whatever limitations we’ve got, it’s always better to acknowledge them and adjust, than to deny them.

Overestimating what you’re capable of knowing or doing can be extremely dangerous—in sports, business, or investing. Knowing and acknowledging the boundaries of what you can know, working within your circle of competence rather than venturing beyond, and always double checking your conclusions can give you a great advantage. As Mark Twain remarked, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”