The Invisible Gorilla: And Other Ways Our Intuitions Deceive Us (22 page)

What went wrong for the subjects who got monthly feedback? They got a lot of information, but it was short-term information that was not representative of the true, long-term pattern of performance
for the two funds. The short-term information created an illusion of knowledge—knowledge that the stock fund was too risky, in this case. The monthly-feedback subjects had all the information they needed to generate actual knowledge—that the stock fund was the better long-term investment—but they didn’t manage to do so.

The same thing happens in the real world of investing decisions. Brad Barber and Terrance Odean managed to obtain six years of trading records for sixty thousand accounts from a brokerage firm and compared investment returns between people who bought and sold stocks frequently and those who traded rarely. Presumably investors who make lots of trades believe that they have lots of knowledge and good ideas about stocks—that each of their trades will make money because it is anticipating a market move. But once their returns were adjusted for the costs and tax payments generated by all the trades they made, the most active traders earned one-third less per year than the least active ones.
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Professional and amateur investors alike should seek the best rates of return they can get, balanced against the level of risk they are taking. Individual investors in particular may be better off paying more attention to the riskiness of their portfolios than they currently do. Earning an extra few percentage points on your money may not be worth the anxiety, lost sleep, and bad temper that can accompany the volatility of large price swings. To make truly informed financial decisions, you must have an accurate picture of the long-term returns
and
short-term volatility you should expect from each of your investment options, and you must evaluate these factors in light of your own ability to tolerate risk.

We are generally taught that it is better to have more information than to have less. Who wouldn’t want to consult
Consumer Reports
before purchasing a car or a dishwasher? Who wouldn’t want to know the price of a flat-screen TV at three different stores rather than just one? And in these cases, more information does make for better decisions (at least up to a point). The studies we just presented, and others like them, suggest that investors who have more information also believe that they
have better knowledge. But when that information is in fact uninformative, it only feeds the illusion of knowledge. In reality, most short-term fluctuations in value are unrelated to longer-term rates of return and should not determine your investment decisions (unless you are investing money that you might need in the near future, of course). When it comes to assessing the long-term characteristics of an investment, sometimes having more information can result in less real understanding. What the Thaler group’s experiment showed was that paradoxically, people who got the most feedback about the short-term risks were least likely to acquire knowledge of the long-term returns.

The illusion of knowledge can’t predict the timing and magnitude of each financial bubble—in fact, knowing about the illusion should make us just as wary of attempts to predict price drops as price increases. The illusion of knowledge does appear to be a necessary ingredient for the formation of bubbles, though. Each historical bubble has been associated with a piece of new “knowledge” that was disseminated so widely that it eventually reached people who knew nothing else about finance except for that one piece of information (tulip bulbs are a can’t-lose investment, the Internet will fundamentally change what companies are worth, the Dow is going to 36,000, real estate never loses value, and so on). The proliferation of information about finance, from cable news networks to websites to business magazines, is a recipe for the illusory feeling that we know how the markets work, when all we really have is a lot of information about what they are doing at the moment, what they have done in the past, and how people
think
they work, none of which necessarily predicts what they will do in the future. Familiarity with the language of finance and the immediacy of market changes often masks a lack of deep knowledge, and the increasingly rapid flow of information may even shorten the cycle of booms and busts in the future.

Much as we cannot focus attention on more than a limited subset of our world and we cannot remember everything around us, the illusion
of knowledge is a by-product of an otherwise effective and useful mental process. We rarely need to explain why something works. Rather, we just need to understand how to work it. We need to understand how to unclog a toilet, but we don’t need to know how flushing the toilet causes water to empty from the bowl and then to fill it back up. Our ability to operate a toilet when we need to—and to do so without even thinking about the process—gives us a sense that we understand it. And for most practical purposes, that is all the understanding we really need.

In
Chapter 2
, we discussed the error of “change blindness blindness”—the idea that people think they will notice changes that, in reality, they rarely do. People easily confuse what they actually remember with what they potentially
could
remember if given the chance to study things further. Stop reading now and draw a picture of the face of a penny, or form an image of one in your mind. Odds are that your image has at least a couple of errors—you might have Lincoln facing the wrong direction, or you might have put the date in the wrong place, or you might have forgotten to include the date altogether. You have seen pennies every day for years, and before now you probably thought you knew what a penny looked like. You do know enough to tell a penny apart from other coins, which is the only knowledge you really need.
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Ronald Rensink, a vision scientist at the University of British Columbia and a leader in the study of change blindness, has made the interesting proposal that the mind works much like a Web browser. Chris’s father, a smart man born long before the digital computer was invented, has asked Chris several times over the years to explain how all the information from the Internet gets into his “set,” his quaint name for his iMac. Most of us know that the contents of the Internet are distributed across millions of computers around the world, rather than being duplicated inside every desktop computer. But if you had a fast enough Internet connection and there were fast enough servers on the network, you would not be able to see any difference between these two accounts of how the Internet works. From your perspective, the information you want arrives as soon as you request it; you follow a link with your Web browser, and the contents of the page appear almost immediately. The
perception that the Web is stored locally on your computer is a reasonable misunderstanding, and in most cases, one that would make no difference to you. When your Internet connection goes down, though, your “set” no longer has access to the information you thought was inside it. Similarly, the experiments in which we don’t notice people changing into other people reveal how little information we store in our memories. We don’t need to store this information any more than our computers need to store the contents of the Web—in each case, under normal circumstances, we can obtain the information on demand, whether by looking at the person standing in front of us or by accessing sites on the Internet.
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Companies often prey on the illusion of knowledge to hawk their wares, emphasizing technical details in a way that leads people to think they understand how a product works. For example, audiophiles and audio cable manufacturers regularly wax poetic about the quality of the cables that connect different system components. Cable manufacturers tout the superior shielding on their cables, greater dynamic range, higher-quality copper, gold-plated connectors, and cleaner sound. Reviewers say that the cables make their old speakers sound like new ones, and that there is simply no comparison between the high-end cables and regular cables. In at least one informal experiment, though, audiophiles in a blind test could not distinguish one expensive set of cables from wire coat hangers used as speaker cables!
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All of the high-tech cable technology made little difference in the sound of the music. Of course, it is possible that the other components in their stereo systems might have been of insufficient quality to reveal the difference, but most people listening to music or watching movies on a home theater system wouldn’t have the sort of equipment necessary to detect the difference either.

The hype is much funnier in the case of cables that transmit digital signals. As long as a cable is able to transmit the 0s and 1s that make up a digital signal, the quality of the wire doesn’t matter one bit. The factor
that matters is the protocol used to generate and interpret those 0s and 1s. Modern stereo systems and video systems use digital standards such as HDMI to transfer information from one component to another. Yet prices on HDMI cables vary by more than a factor of ten: A cable that costs $5 will transmit the signal just as well as a cable that costs $50. Denon even sells a 1.5-meter Ethernet cable for audio systems that is priced at $500. Here is the product description at Amazon.com:

Apparently, some people have actually bought this product, but as reviewers on Amazon.com point out, since the signal is digital rather than analog, there is no reason to expect any difference in sound quality between this cable and an ordinary Ethernet cable you can get from your local dollar store. It’s not even clear what “jitter” and “ripple” mean, why vibration matters for a stream of 0s and 1s, or how fluoropolymers prevent aging. Most of the hundreds of reviews of this product on Amazon.com are facetious, and the five most commonly associated customer tags for it include “snake oil,” “ripoff,” “waste of money,” “throwing your money away,” and “unconscionable.”
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A group of researchers in the Yale psychology department, including Dan’s graduate school adviser, Frank Keil, and our friend Jeremy Gray, conducted a mischievous experiment in which subjects read passages
of text that included some uninformative babble like the description of Denon’s cable. Each passage began with a straightforward summary of a psychology experiment like the following:

After reading this passage, subjects would then read either a good or a bad explanation for the “curse of knowledge.” The “bad” explanation for the curse of knowledge was the following: “This ‘curse’ happens because subjects make more mistakes when they have to judge the knowledge of others. People are better at judging what they themselves know.” Note that this explanation doesn’t actually tell us anything about the “curse of knowledge.” The experiment showed that people judge the knowledge of others differently depending on whether they themselves have the knowledge. It said nothing about whether we are better at judging our own knowledge or the knowledge of others.

In contrast, a “good” explanation read as follows: “This ‘curse’ happens because subjects have trouble switching their point of view to consider what someone else might know, mistakenly projecting their own knowledge onto others.” This explanation is good because it explains the curse of knowledge in terms of a broader principle about our minds—the difficulty we have in adopting another person’s perspective. The explanation may or may not be scientifically correct, but at least it is logically relevant.

Each subject read a series of these passages and explanations and rated how satisfying each explanation was. Generally, people rated the good explanations as more satisfying—they recognized that the good
explanations actually said something to explain the experimental result, and the bad ones were largely irrelevant.

The twist in the experiment came from a third condition, in which irrelevant information about the brain was added to the bad explanation: “Brain scans indicate that this ‘curse’ happens because of the frontal lobe brain circuitry known to be involved in self-knowledge. Subjects make more mistakes when they have to judge the knowledge of others. People are much better at judging what they themselves know.”

Much as the technobabble in the cable description on Amazon.com doesn’t turn a $2 bundle of wires into a $500 gadget, this superfluous brain-talk, which we like to call “neurobabble,” does nothing to rescue the validity of the bad psychological explanation. But the subjects rated the bad explanations that included neurobabble as more satisfying than those that did not. The neurobabble induced an illusion of knowledge; it made the bad explanations seem like they imparted more understanding than they actually did. Even students in an introductory neuroscience course were influenced. Fortunately, neuroscience graduate students had enough actual understanding to immunize them to the neurobabble.
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