Richard Thaler: ‘We Are Incapable of Learning From the Past’

Valerio Baselli:

Hello, and welcome to Morningstar. I'm Valerio Baselli. Today, I'm very pleased and honored to receive a real pioneer in behavioral economics, the father of the Nudge theory, professor at the University of Chicago Booth and awarded in 2017 with the Noble Prize in Economic Sciences, Richard Thaler.

Thank you, professor, for joining me today.

Richard Thaler:

It's a pleasure.

Baselli:

So, behavioral economics is a relatively new and rapidly expanding field of research that at the end of the day says to traditional economists, "Be aware of irrationality and emotions and all the psychological aspects of human beings." Why these considerations were not taken into account from the start?

Thaler:

The interesting thing is they

were

taken into consideration at the start and then they were forgotten. Adam Smith is often thought to be the inventor of modern economics. He talks about loss aversion, overconfidence, generosity, emotions. He was a behavioral economist. And economics was behavioral through John Maynard Keynes, who was the great prewar economist. And then, economists forgot about people, and they forgot about them for 50 years.

Baselli:

Right. And now, thanks to your success, do you think the behavioral side is taken into consideration by current economists or, even more importantly, by decision-makers as governments?

Thaler:

Well, we're making inroads in economics. Every young economist knows about behavioral economics, and every top department has behavioral economists, and every top journal publishes behavioral economics. It hasn't made its way into the textbooks because it complicates the story. Undergraduates taking a basic economics course, they may get one chapter, but the professor finds it a little inconvenient. As to decision-makers, I would say there's growing understanding, both in governments and in the business community, but it's still, like you say, it's a new field.

Baselli:

Right. Let's talk about the markets now. The current situation is very challenging, of course. Do you think that despite everything that is going on in the world, the strong correction we are experiencing right now is somehow physiological after a long period of equity markets smashing all-time records, with Wall Street leading the way, of course?

Thaler:

Yeah. When you're in a period that seems to be a bubble, you never know when it's going to end. If you go back to the tech bubble of the late 1990s, many observers, including me, started to say, "Look, these tech stocks are overpriced," and in 1996 and 1997 and 1998, and of course, the correction didn't happen until 2000. And today, we don't know whether this period is the beginning or the end of the so-called correction. It seems clear that some parts of the market were overvalued, but you can never prove that. And so, these so-called meme stocks seemed transparently ridiculous, but anybody who took the short position lost all their money.

Baselli:

Right. But as you said, investors' nerves have been tested in several occasions over the last few years. The outbreak of the pandemic, now the inflationary spike, and of course, the war in Ukraine. But if you think about it, even the Greek and the European sovereign debt crisis are not so distant in time, and neither is the subprime crisis in the U.S. So, are we able to learn from the crisis of the past?

Thaler:

There doesn't seem to be any evidence that we do learn. Traders tend to be young. It's a young person's game—mostly, a young man's game still, because it's one field that women have not made big inroads. But it's a young person's game, and I talked to my students about the tech bubble. "What was that?" Right? That's only 20 years ago. And of course, 1987, when stock markets fell 20% in a single day—nobody knows what I'm talking about. So, I don't think we learn, and we may not make exactly the same mistake. That's what I do: I make a different mistake each day, not the same one. (laughs) And so, who knows.

Baselli:

Right. And I understand that, as investors, our instincts are most of the time all wrong. But does this mean that we should remove the human component from investment strategies? Is this the solution: to give the decision power to an automatic pilot? Or is it preferable— a nudge?

Thaler:

I would say, it depends on the situation. For most individual investors, they are better off using a rule. Let's not specify where that rule comes from. And the reason is, their instincts are all wrong. They buy high, sell low. If you were smart enough to start selling at the beginning of the year, well, congratulations. But the smart individual investors are well-advised to have a diversified portfolio and then leave it alone. I always tell people: Ignore the market, watch the football, and it's safer for your ... now, of course, it makes sense to keep rebalancing, but trying to guess whether this is the time to buy the dip, I'm not smart enough to do that.

Baselli:

My last question for you, professor: It is now quite common to think that financial advisors should receive some kind of training in psychology as well. Would it be useful in your view?

Thaler:

I think a good financial advisor is part economist, part psychologist. And if a financial advisor doesn't know how to talk to their clients during these periods, they have no business being a financial advisor. Now, it's just like a physician, right? Some doctors have a better bedside manner, and some financial advisors are more attuned to that, but I think understanding the psychology of the client is essential to being a good advisor.

Baselli:

Right. Thank you so much, professor, for having shared your insights with us today.

Thaler:

It's a pleasure.

Baselli:

For Morningstar, Valerio Baselli. Thanks for watching.