Why smart people make bad decisions

http://finance.yahoo.com/news/why-smart-people-make-bad-decisions-132828672.html?soc_src=mail&soc_trk=ma

“One of the most persistent fallacies is the reflexive association of wealth with wisdom,” investor Ed Borgato tweeted this week.

Another is the association between intelligence and good decisions.

Not only are they two separate things, but there are instances where high intelligence prevents people from making better decisions.

Here are two I’ve seen.

1. Intelligence increases the ability to fool yourself with elaborate stories about why something happened.

Average people can often learn faster than the super-intelligent, because the super-intelligent try to cram the real world into the theories they’ve been taught, while average folks are better at accepting the real world at face value.

Here’s the thing: We judge others based solely on their actions, but when judging ourselves we have an internal dialogue that justifies our mistakes and bad decisions.

If you’re a fund manager who earned terrible returns, I may be able to instantly point out what went wrong: Buying during a bubble, selling during a panic, not enough diversification, whatever.

But if I’m a fund manager who earns terrible returns, I can tell myself a story justifying my decisions and explaining the outcome. “The Fed distorted the economy” I might say, or “Look at my model. It’s the market that’s wrong!”

Two things come from this.

One, we think of ourselves as less flawed than other people, because we rarely hear the internal justifications other people have for their mistakes, but we’re keenly aware of our own.

Two, the smarter and more creative we are, the more elaborate stories we can tell ourselves to justify our poor decisions.

A normal person could never predict 19 of the last two bear markets and still consider themselves a market oracle. You need an advanced degree and an Excel model with 100 tabs to justify that kind of mental gymnastics. A normal person isn’t capable of leveraging their portfolio 100-to-1, losing everything when the market sneezes, and blaming it on a 25-sigma event. You need a PhD in physics to convince yourself of that.

When you’re blessed with intelligence you’re also cursed with the ability to use it to concoct intricate — and often false — stories about why things happened. Especially stories justifying why you, Mr. Smartypants, made a mistake.

2. Intelligence pushes you toward the idea that complex problems require complex solutions.

Try spending a quarter million dollars on a PhD program and then devoting your career to telling people that you can’t predict the economy, or that they should just buy index funds. It must be hard. You worked hard and spent a fortune learning something complex, and you want to use what you were taught.

But some of the most complex problems require the simplest solutions, since simple solutions are the ones that navigate around — rather than trying to steer through — parts of a problem that are fundamentally unknowable. The brilliance of a dollar cost averaging strategy is not that it knows what the market will do next. It’s that it doesn’t need to know for it to work.

Robert Weinberg, a brilliant MIT cancer researcher, once explained why people like himself aren’t interested in simple solutions, even when they’re effective:

Persuading somebody to quit smoking is a psychological exercise. It has nothing to do with molecules and genes and cells, and so people like me are essentially uninterested in it – in spite of the fact that stopping people from smoking will have vastly more effect on cancer mortality than anything I could hope to do in my own lifetime.

The irony of some of our biggest problems is that they have solutions too simple for the people working on them to find intellectually stimulating. The same is true for companies that can innovate like geniuses but consider brand, UX, and marketing too simpleminded to care about.

Even when a problem requires a complex solution, the ability to communicate it in simple terms is indispensable to getting people to take you seriously. Albert Einstein, Warren Buffett, and Steve Jobs are all brilliant, but a lot of people are brilliant. What made them famous is their ability to distill complexity into something elegant and simple enough for average people to understand, or even use.

Sometimes I wonder: How many academics have discovered something amazing, but written it in a paper that’s so dense and complex that no one else can understand it?

A lot, I imagine.