McArthur Wheeler's flawed plan... The cognitive bias involved in his misstep... A 50-percentage-point chasm between perception and reality... How this sensation differs from 'stupidity'... The key to protecting yourself from excessive self-confidence... Our 'circle of competence' and your investing journey...
When the police came knocking shortly after midnight, McArthur Wheeler couldn't believe it...
Sure, just hours earlier, he had walked into two Pittsburgh banks in broad daylight and pointed a gun at tellers. And yes, he had intentionally not worn a mask... He even grinned into security cameras at both banks, allowing them to get unmistakable images of his face.
All the local TV stations shared the footage during the 11 p.m. newscast on April 19, 1995... And within minutes, tips about Wheeler's identity and location came rolling in to police.
"But I wore the juice!" Wheeler said when officers showed him the surveillance footage.
You see, Wheeler believed he had devised a foolproof plan to evade detection... lemon juice.
Wheeler knew that lemon juice could serve as invisible ink. It becomes visible only when exposed to heat. So as long as Wheeler avoided anything hot, he figured the juice would keep his face invisible to the cameras. He even tested out the scheme ahead of time...
Before the holdups, Wheeler rubbed lemon juice all over his face. Then, he used a Polaroid camera to take a picture... and his face didn't show up. (Of course, Wheeler also said the lemon juice stung his eyes, so he likely aimed the camera in the wrong direction as well.)
As the rest of us know, lemon juice doesn't actually work that way... While it's invisible on paper, it has no such power for human skin. So in the end, Wheeler went to jail. And he ultimately became known as one of the most incompetent criminals in American history.
But as I (Kim Iskyan) will explain in today's Digest, he's far from alone when it comes to the depths of his own ignorance and in his misplaced confidence based on incorrect insights...
In this essay, we'll cover the cognitive bias involved in Wheeler's costly misstep... how common – and dangerous – it is... how you may be guilty of it yourself (and not know it)... and how to protect yourself from your own (and others') lack of awareness to shortcomings.
Wheeler's story caught the attention of psychologist David Dunning in the late 1990s...
At the time, Dunning worked at Cornell University. Along with his graduate assistant, Justin Kruger, he designed a series of experiments to test the idea that clueless people like Wheeler tend to overestimate their abilities...
Students in the experiment were asked to perform certain tasks – like assessing logic, grammar, and humor. The subjects were then asked to estimate how well they thought they fared on the questions, including ranking their performance relative to other students.
Dunning and Kruger found that the survey respondents who scored the worst consistently overestimated their performance... Specifically, those who actually scored in the 12th percentile, on average (meaning just 12 respondents out of 100 scored worse), estimated that they had scored in the 62nd percentile (that is, they thought they beat 62 out of 100).
That's a huge, 50-percentage-point chasm between perception and reality.
(As a quick aside, people who do the opposite – score well but think they did poorly – suffer from what's called "imposter syndrome"... That's when someone believes he's not as skilled, talented, or accomplished as others perceive him to be. He feels like his triumphs are due to luck, rather than his intelligence, qualifications, and hard work. And according to one study, about 70% of people experience imposter syndrome at some point in their lives.)
Overconfidence can be dangerous to ourselves, others, and of course, our money... When we don't recognize (and even worse, can't recognize) that we're bad at or wrong about something in our daily lives, it sets us up for failure from the beginning.
And then, it gets worse when we overestimate our ability and knowledge, rather than just accepting this incompetence or our shortcomings. We instead feel empowered by misplaced confidence and bolstered by something that feels like (but isn't) actual insight or skill.
That's when we make decisions and take actions that hurt ourselves and others – though hopefully not as extreme as robbing a bank, like Wheeler. This lack of self-insight on our own incompetence is now called the "Dunning-Kruger effect" after the two researchers...
In other words, it's when incompetent folks think they're great at something... but they're not – and they don't even realize it. And this "illusion of confidence" extends beyond just factual knowledge to all sorts of different excessive beliefs in one's own abilities...
In fact, according to Dunning, it also could be known as the 'American Idol effect'...
The reference was in the running for the official name because the TV singing competition often delivers the spectacle of tone-deaf contestants who seem convinced that their talents will lead them to stardom... while viewers hit the mute button on their TV remotes.
Of course, it's statistically impossible for everyone to be better than most people...
It's like the fictional small town Lake Wobegon in American author and radio personality Garrison Keillor's A Prairie Home Companion, where "all the children are above average."
It's in that same universe where, in another study, 80% of drivers rate their skills behind the wheel as above average... where people tend to see themselves as "more honest, more talented, and more hard working than others," another study explains... and where "people give self-serving estimates of their own standing in social networks" in yet another study.
And it's where overeager teenagers challenge retired – but still otherworldly athletic and talented – professional basketball players to a game of one-on-one... and learn that even career benchwarmers are vastly more talented than all but a small group of folks on Earth.
But this is a good time to note that these folks aren't necessarily what we would call "stupid"...
Stupidity is (often) something different...
In the April 8 Digest, I wrote about the part-satire, part-scholarship, all-real-life definition of "stupid" that Italian economic historian Carlo Cipolla developed in the 1970s.
Cipolla said that hardcore, toxic stupidity is well beyond the relatively harmless garden-variety examples we often experience – like doing something dumb ("where did I put my keys?") or holding baseless opinions ("if you go out in the rain, you'll catch a cold.")...
Cipolla contended that a stupid person is someone who intentionally does things that hurt or disadvantage others – even if he doesn't derive any benefit from his actions, and although he himself may even suffer from his own actions.
As he explained in what was eventually published as "The Basic Laws of Human Stupidity" – and as I shared in that Digest a few months ago...
Our daily life is mostly made of cases in which we lose money and/or time and/or energy and/or appetite, cheerfulness and good health because of the improbable action of some preposterous creature who has nothing to gain and indeed gains nothing from causing us embarrassment, difficulties or harm.
Nobody knows, understands or can possibly explain why that preposterous creature does what he does. In fact there is no explanation – or better there is only one explanation: the person in question is stupid.
The "confident idiot" may also be stupid – as was the case with Wheeler, the would-be bank robber who ticks all the relevant boxes... But depending on the underlying intent, stupidity and folks who suffer from the Dunning-Kruger effect don't often overlap.
Stupid people and sufferers of the Dunning-Kruger effect do always share one important trait, though...
They don't know just how stupid or incompetent they are.
Like the rest of us, stupid people certainly don't view their motivations or actions as stupid. Stupidity doesn't allow for the rational introspection that would lead someone to conclude... "Yes, in fact, I am stupid."
As British comedian Ricky Gervais once said, "The best thing about being dead is that you don't know about it. It's like being stupid – it's only painful for others."
And similarly, as Dunning explains, people who suffer the illusion of confidence aren't even equipped with the tools to recognize their ignorance. As he wrote in the Pacific Standard online magazine in 2014...
Logic itself almost demands this lack of self-insight: For poor performers to recognize their ineptitude would require them to possess the very expertise they lack.
In other words, to recognize that you're a bad singer, you'd actually have to be able to carry a tune in the first place. And to appreciate that your layups and three-pointers are made for the playground and not the professional ranks, you'd have to be pretty good at basketball.
By this point, you might be wondering how the Dunning-Kruger effect relates to investing...
Oftentimes, having excessive confidence in your own competence will lead to nothing more serious than a bruised ego or a scraped knee once your incompetence is revealed to you.
But when it comes to matters like medicine and money, the Dunning-Kruger effect can be a lot more dangerous...
Thanks to search engines like Google, amateurs can quickly build the false confidence to self-diagnose and self-medicate. But that's no substitute for the expertise of a real-life doctor with four years of medical school, followed by as many as seven years of residency.
When it comes to your health, you should always trust the experts.
And it's a similar story with investing... Like a lot of things in life, making money from buying (or selling) stocks and other financial assets looks easy on the surface.
Nothing more than a half-hour market update on CNBC and a few ticker symbols picked up from a segment on Fox Business can give novice investors the illusion of competence. So can an "everything bubble" market in which almost every asset goes up (sound familiar?)... or a random speculation like Dogecoin, which is up more than 120 times over the past year.
After all, it seems like investing is just about picking the right ticker symbols.
It's that kind of market atmosphere and euphoric state of mind that leads to unjustified self-confidence of the type identified by the Dunning-Kruger effect... It's what you see before the incompetence of scores of inexperienced investors is eventually and inevitably revealed.
And of course, that won't be delivered in the form of a viral YouTube video of American Idol warbling... It only becomes evident after you've lost a significant amount of your wealth.
So how can you insulate yourself from the collateral damage of your own excessive self-confidence?
First of all, learn to say, "I don't know."
It isn't shameful to admit that. It might spare you a lot of pain – psychological, physical, emotional, and financial – later on. And you can learn something from the experience.
Part of that process is knowing how to stay in your lane. In other words, focus on what legendary investor Warren Buffett calls your "circle of competence." As he said...
The size of that circle is not very important; knowing its boundaries, however, is vital.
When you know the boundaries of your circle of competence, you can easily determine what's outside of it. And from there, you can find people for whom a particular task or challenge is within their circle of competence...
If you need a steak-knife juggler for your grandkid's birthday, call up the clown company. If you feel dizzy and can't catch your breath, skip WebMD and go to the doctor or hospital.
Along the same lines, it's OK for you to acknowledge that you're not the world's best investor...
Perhaps you could use some additional insight before making any decisions...
That's exactly what we're here for at Stansberry Research.
Ultimately, we can't make any investments for you. And as regular readers know, we can't offer any personal investment advice when you write in to us. When it comes down to it, only you control your investing future. But we can certainly guide you along the way...
We've spent the past two decades assembling one of the best teams of experts you'll ever find. Our editors and analysts cover all corners of the markets – whether it's small-cap growth (American Moonshots), deep value (Extreme Value), cryptocurrencies (Crypto Capital), precious metals (Gold Stock Analyst, Silver Stock Analyst, and Stansberry Gold & Silver Investor), distressed corporate bonds (Stansberry's Credit Opportunities), cannabis (Cannabis Capitalist), and the list goes on... This is just a sampling of our broad reach.
Like anyone, we're not perfect. We sometimes make missteps, too... But in the end, this is our circle of competence. We're glad we can be a part of your investing journey.
And of course, if you're interested in learning more about any of our products and services, we encourage you to check out our website right here. It doesn't matter if you're a retiree looking to preserve your nest egg or someone who wants to find the next 10-bagger in technology stocks... We're confident you'll find something that suits your needs.
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In today's mailbag, feedback on yesterday's Digest about an "early warning signal" for U.S. stocks... and a comment stemming from our discussion last week about discount retailers. Do you have a question or comment? Praise or rage? As always, e-mail us at feedback@stansberryresearch.com.
"Thank you for one of the most informative and well-written Digests – really helpful and educational." – Paid-up subscriber Richard C.
"TJX price-earnings: approx. 55... TGT p/e: 20... TJX better be making some seriously big money if it's going to be an investment." – Paid-up subscriber Phil B.
Corey McLaughlin comment: Phil, great point. I want to make an important distinction just to clarify...
I was commenting on the business model of TJX Companies (TJX)... and intended only to show that the business can source products from various places – meaning not just major retailers (that may or may not go out of business soon, which was the question at hand).
The valuation of TJX shares is another story... As you point out, the company's price-to-earnings ratio is around 55 today. That's not quite Tesla (TSLA) territory – which is trading at 580 times earnings today – but it's significantly higher than the P/E ratio of even the benchmark S&P 500 Index, which is at a historic high of about 46 right now.
In other words, TJX is an expensive stock... but that doesn't mean the company doesn't have a good, timeless business approach, as we talked about (including capitalizing on market inefficiencies). It just means enough people are willing to pay $68 for shares today.
This reminds me... if you want to check out TJX in more depth (or any publicly traded stock, for that matter), be sure to check out our new StansberryInvestor.com. It's a one-stop shop for all of our current and past research.
I popped TJX's ticker into the search box and saw that our colleague Dan Ferris recommended the stock way back in December 2008 in his Extreme Value advisory. Back then, shares were cheap (and TJX was also a good business). Subscribers who followed Dan's advice booked about a 50% gain in six months.
Good investing,
Kim Iskyan
Reston, Virginia
July 7, 2021