Our lives are filled with randomness and change, and we must make various judgments and decisions amidst this unpredictability. Often, when we look back, we find that there are always some events, big or small, that influence our judgments at every decision-making moment, even determining each decision and potentially having an unimaginable impact on the future at the time.

For instance, deciding to invest might stem from a chance encounter with an article; resolving to buy a particular fund could be due to a friend's recommendation; hastily selling might be triggered by comments seen on social media platforms...

We all hope to make correct judgments and be responsible for our decisions, but distractions are omnipresent. These distractions can generally be divided into two categories: one is bias, which Nobel laureate in Economics Daniel Kahneman focused on in his book "Thinking, Fast and Slow," published a decade ago; the other is noise, which Kahneman, along with Olivier Sibony, and Cass Sunstein, co-author of "Nudge," aim to reveal in their new book "Noise: A Flaw in Human Judgment."

Both biases and noise can lead us to make mistakes, but what is the difference?

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"Thinking, Fast and Slow" specifically examines the biases in the decision-making process, demonstrating how the unconscious "System 1" and the conscious "System 2" work together in our brains to make decisions. System 1 adheres to the principle of seeing as believing, allowing illusions such as loss aversion and optimistic bias to guide us into making wrong choices.

The manifestations and causes of these errors vary, but they all share a commonality: they have a "directionality," affecting different people in the same way. In Kahneman's words, a bias is a "predictable judgment error."

In the book "Noise," the authors further investigate the errors in decision-making behavior and argue that while biases pull errors in one direction, noise scatters errors in various directions.

The impact of noise is random, unpredictable, and difficult to detect.For example, sometimes we make decisions on whether to continue holding or sell a fund based on some superficial phenomena. When we see a fund we hold reaching a new net value high, we might think that the entire market also looks prosperous, and this fund should continue to be bought.

However, what we fail to realize is that our judgment has been affected by noise. If we see the news of our held fund reaching a new high at a different time, we might make a completely opposite judgment. For instance, we might suddenly pay attention to the fact that the fund's size has increased significantly with the new high, gaining market attention, and we worry whether this will affect the fund's performance, so we decide to sell and take profits.

In fact, the fund manager has not made adjustments, the investment style has not drifted, and there have been no management issues with the fund company... The fundamentals of the fund seem unchanged, yet we have made different judgments, which is the influence of noise.

Three Types of Noise and Their Impact on Our Judgment

The book "Noise" illustrates for us the three types of noise that coexist and act together. If expressed in a formula, it is:

Systematic Noise = Level Noise + Stable Pattern Noise + Situational Noise

In the face of the same investment information, some people are more tolerant, optimistic, and positive than others. The difference between these individuals and the average of the population is the "Level Noise." Any judgment will have varying degrees of level noise. For the same fund performance, some holders may be more tolerant, while others may not, so the difference presented is a "Level Noise" for an investor who needs to make decisions based on this.

"Pattern Noise" refers to the variation in people's reactions to specific events, which is also a personal tendency and can also affect the judgment outcome. An investor may generally be more lenient when evaluating what makes a good fund, but may have their own preferences regarding the fund manager's appearance. This specific tendency is the "Stable Pattern Noise," which can seriously interfere with predictions.

"Situational Noise," on the other hand, is the most difficult type of noise to detect and measure. Factors such as mood, weather, stress, and fatigue can all bring such situational noise to our judgment. For example, if we are in a bad mood today and therefore find some aspect of the fund unsatisfactory, even making a decision to redeem based on this, it is a manifestation of being disturbed by "Situational Noise."

The source of situational noise is our emotions.Emotions have predictable effects on our thinking, relating to what we pay attention to in our environment, what information we retrieve from memory, and how we interpret that information. Emotions can also alter our thought processes. Positive emotions are a double-edged sword, and negative emotions might also offer a glimmer of hope in difficult situations. The advantages and disadvantages of different emotions depend on the specific context.

As emotions fluctuate, whether we are aware of it or not, our cognitive mechanisms change as well. If we are faced with a complex judgment problem, our current emotions will affect our thinking about this issue and the conclusions we draw, even if we believe our judgment is not influenced by emotions and can confidently articulate the reasons for our answers.

For example, if you are in a good mood today, when your held fund declines by 1%, you might recall articles you've read about viewing the long-term performance of funds rationally and the short-term fluctuations, and consider that such short-term changes do not fundamentally affect long-term holding. Conversely, if you are in a bad mood, even if your held fund increases by 1%, you might focus on the fund rankings and think that other funds have risen more, simplistically judging that your held fund lacks upward momentum and that you should switch to a fund that has increased more.

This is the impact of situational noise on our judgment.

Understanding of Noise

Noise is easily overlooked because people favor "causal thinking." Causal thinking leads people to create connections where there are none and to find patterns where there are none.

Our understanding of the world depends on our ability to construct stories to explain the events we observe. And we are almost always successful in finding causes because we can search for reasons from countless facts and beliefs. For instance, there are few large fluctuations in the stock market that cannot be explained; people can always find various reasons to interpret them.

When are we confident in our judgments? Generally, two conditions must be met: the story we believe in must be completely coherent, and there should be no other attractive reasonable explanations. When all the details of the explanation perfectly match and reinforce the story, the story achieves complete coherence. Of course, this coherence can also be achieved by ignoring incongruent events or by providing additional explanations.

"Causal connections" strengthen our understanding and judgment of things, which may lead us to overconfidence and thus turn a blind eye to the existence of noise. However, the first step in reducing noise is to acknowledge that it might exist.

In the book "Noise," a survey of 400 forensic experts from 21 countries showed that 71% agreed that "cognitive biases are a worrying factor in the entire field of forensic science," but only 26% believed that "their own judgments were affected by cognitive biases."So, are we influenced by noise during the process of fund investment? This might be indirectly understood from our awareness of how much we know about financial investment knowledge.

According to data from the China Securities Investment Fund Industry Association in the "2019 National Public Fund Investor Survey Report": 53% of individual fund investors have received financial education in schools. Additionally, individual investors who have acquired financial knowledge through self-study of financial textbooks and books account for 25.2%. The report notes that it is worth paying attention to that 20.4% of investors have not received or self-studied any financial education.

However, it is interesting to note that as many as 93.4% of investors believe that their level of financial knowledge is above or at the average level of their peers, and this is similar to the proportion of the survey data from the previous year. Only 6.6% of investors believe that their financial level is below or far below the average level of their peers.

When the vast majority of fund investors in the market believe that their level of financial knowledge is above average, it forces us to consider what kind of noise impact this will have on investment decisions. Such overconfidence cognitive bias is often used to explain some poor decisions.

In addition to recognizing the impact of noise on judgment, we should also pay attention to the impact of cognitive style on judgment. A proactive and open mindset will be beneficial.

Proactive and open thinking refers to an individual's willingness to actively seek information that contradicts their previous assumptions, including different opinions from others and new evidence that is inconsistent with their original views.

If you want to reduce incorrect judgments, the best approach is to be open to opposing views and willing to accept the idea that "you might be wrong." If you still want to insist on your own opinion, it should be after listening to all sides, not before. But the good news is, some evidence suggests that proactive and open thinking is a skill that can be learned.

Six principles and three steps to reduce noise

The book "Noise" believes that noise is essentially a statistical concept, and everyone will deviate in different directions. Therefore, to reduce the interference of noise, there is a simple method, which is to find more independent external viewpoints and take the average, allowing the noise to cancel each other out, so as to make better judgments.To address this, the author employs the metaphor of "decision hygiene," suggesting that reducing noise is akin to maintaining everyday hygiene to prevent unknown viruses from entering the body, and it can also prevent the emergence of unknown errors.

The six principles of decision hygiene are:

1. The purpose of judgment is accuracy, not personalized expression.

2. Employ statistical thinking and adopt an external perspective to examine individual cases.

3. Structure judgments by breaking them down into several independent tasks.

4. Resist premature intuition.

5. Obtain independent judgments from multiple judges and then consider aggregating these judgments.

6. Relative judgments and relative scales are preferable.

To maintain our decision hygiene, we can organize the aforementioned six principles and follow a simple three-step process: decompose indicators - independently score - make overall judgments.

Decomposing indicators, a principle of divide and conquer, is necessary to address the psychological mechanism we call over-consensus (brought about by cognitive dissonance). Over-consensus can lead people to distort or ignore information that does not align with their existing conclusions. By breaking down the problem into a series of smaller tasks, we can reduce this influence to some extent, ensuring that each assessment can be conducted independently.Independent scoring is crucial, and it is advisable to allocate these indicators to different individuals or teams for investigation and research. In this phase, independence is of utmost importance; otherwise, the noise effect may be exacerbated through collaboration. If the second person giving an opinion is aware of the first person's opinion, then the second person's opinion is no longer independent, and it becomes even less likely for the third person's opinion to maintain independence. Consequently, a series of biases emerge.

Overall judgment involves obtaining independent conclusions from multiple judges, then consolidating these judgments and deferring the use of "intuition" to this stage. Collecting participants' judgments before discussion can reveal the extent of noise and help resolve disagreements constructively. Averaging a series of noisy judgments may yield more accurate results than unanimous judgments.

The principles and methods mentioned above are applicable in many situations, such as selecting a suitable fund for oneself. We can break it down into several indicators, such as: fund company, investment research capability, fund manager, principal amount to be invested, expected investment returns, investment plan and objectives, risk tolerance, etc., and even further decompose a single indicator, for example, the fund manager, into years of experience, educational background, work experience, investment style, past performance, maximum drawdown, etc. Next, we need to independently seek objective data for scoring, and during the scoring process, we should minimize the interference between different indicators, such as being influenced by a fund's short-term performance when scoring its long-term performance. In the process of gathering information, we should also avoid focusing solely on positive or negative evaluations and should instead search for and base our fair scoring on these decomposed indicators. Finally, make an overall judgment, tally the scores, and on a certain information basis, we can also make intuitive decisions through careful weighing and consideration of the information. We evaluate a fund from different aspects and dimensions, and after evaluating all aspects, we make an overall judgment. This way, the selected fund may be more suitable for our actual needs. A thorough understanding increases trust in the fund, which is much more reliable than blindly buying a fund based on a friend's recommendation.

Where there is judgment, there is noise.

Risk warning:

The views and analyses cited in this material are based on certain assumptions and specific market conditions at the current time, and do not imply suitability for all future market conditions. They do not constitute investment advice for readers, nor do they constitute any promotional materials, investment advice, or guarantees for any business. They are not to be used as any legal documents. The market involves risks, and investment should be approached with caution.