Think Like the Great Investors: Make Better Decisions and Raise Your Investing to a New Level

Chapter 2

Men and women (overconfidence)

Most people have a lack of respect for economists. This partly derives from the basic assumption that underlies classical economic theory. The world that economists study is very complicated. The modern economy has a great number of moving parts, each of which interacts with the others. So there are a huge number of relationships to deal with. Moreover, these relationships change dynamically over time. Economists still struggle even to come close to building an accurate and complete model for how a modern economy operates, let alone have the computational power to run such a model to try to predict what will happen if we change some policy or other.

In order to try to understand the economy at a minimally useful level, classical economic theory was based on an assumption that mankind was totally rational in every decision made. Economic theory assumed that, when faced with a decision, we have all the facts, can weigh them up accurately and will always make a rational choice that maximises the (usually monetary) value to us. This led to the development of useful theories about how the economy worked.

However, anyone who has ever thought for a moment or two about what people actually do, and what they themselves actually do, will realise that these assumptions were bound to limit the usefulness of these theories. They were useful as far ...