Abgeschlossene Halbbildung

We all know that every language has certain words that are not translatable into other languages. The German word “Schadenfreude” (pleasure at the misfortune of others) famously has no equivalent in the English language, even though the millions of “fail” videos on YouTube prove that the concept is universal. Similarly, the English concept of the “property ladder” does not exist in the German language because homeownership rates in Germany are much lower than in the UK or the US and owning a home is not necessarily part of the “German Dream” like it is part of the “American Dream”.

In my view, these untranslatable words often provide a deep insight into the soul of a culture since they express something that a particular culture finds important while another doesn’t. After all, why would you have many different words for snow when you live in a tropical country?

When I was chatting with a friend recently, I came across another one of these concepts that I wasn’t aware of. In German, there is a saying that “Nichts ist gefährlicher als eine abgeschlossene Halbbildung”, which translated into English means something like “There is nothing more dangerous than a finished partial education”. My friend proposed the saying “nothing more dangerous than a job half done” as an equivalent, but these two sentences convey a slightly different concept. While the “job half done” focuses on the quality of the output, the German saying focuses on the amount of knowledge a person has in a subject matter. Germans, as a culture, tend to value knowledge and expertise highly as the tradition of engineering prowess in that country can attest.

And unfortunately, the investment world is full of “experts” that effectively have a finished partial education. One reason why I like my job as a researcher is that it allows me to dig deep into a specific topic and become an expert in that field. Of course, as a practitioner, I will always have less expertise than an academic who specializes in that field. But then again, I have the opportunity to dig deep in a broader range of fields. During my career, I have worked in asset allocation, equity markets and most recently in alternative investments ranging from infrastructure to property and structured finance. I dare say that by now, I know more about these fields than most investors. 

Yet, because I know more about these fields, I tend to be adamant that I know very little about them. This is in my view a reflection of a general principle that your confidence about a field of knowledge changes as you learn more about it. 

Take investing as an example. Most laypeople will readily admit they know nothing about investments and are happy to accept the help of advisers. However, as people learn more about investments, they become more confident in their expertise. The effect is that private investors who become more knowledgeable about investments also become more reluctant to accept the help of others. Furthermore, they tend to gravitate towards investments where they think they know more about than other people. In my career in wealth management, I always joked that I could identify the field of work a client had by looking at his or her portfolio. People who work in the pharmaceutical industry typically favour investments in health care stocks. People who work in IT favour IT investments and so on. With the professional experience and the increased knowledge about a specific area in these industries comes the overconfidence of believing one knows how these industries will perform as an investment. This overconfidence in one’s ability is the area of “Abgeschlossene Halbbildung” and it is the most dangerous level of education an investor can have.

And before you nod your head in agreement, note that financial advisers are subject to the same effect. The worst advisers, in my view, are the ones that have learned a little bit about investing but not enough to understand the big picture. Relationship managers who understand all the details of the products they sell tend to think they are good investors and their advice typically drifts into absolutes, where the uncertainty around the performance of a given product is increasingly covered up and replaced with “guarantees”. Generalist advisers, on the other hand (typically those that are comprehensive financial planners) may not have the level of expertise on specific investment products but it is exactly this lack of expertise that reduces their overconfidence and – ironically – makes them better advisers because they focus on the risks as well as the opportunities and make sure that the risks are such that a client can handle them if they materialize.

Finally, there are a few investors (both private clients and investment professionals) who achieve a deep level of knowledge in a specific area. And with this deeper level of knowledge and expertise comes a lower degree of overconfidence and greater degree of humility. If you ask the developer of an investment product about its risks, this person will typically tell you all the things that could go wrong with the product. The salesperson on the other hand often isn’t even aware of these hidden risks because they got lost in the process of designing and testing the product to marketing it.

The result is the relationship between overconfidence and expertise shown in the chart below. People with little knowledge in a field tend to be underconfident of their abilities. People with some knowledge become overconfident and remain overconfident. However, as the level of expertise grows, the degree of overconfidence declines to more moderate levels. 

This overconfidence curve can have deadly consequences in real life. While the worst that can happen in the investment world is a total loss of capital invested, the worst that can happen in engineering applications is that people die. As Diane Vaughan so brilliantly describes in her book “The Challenger Launch Decision” the assessment of the risk of failure of a launch of the space shuttle Challenger was typically assessed as one to ten to one to a hundred but the engineers who built the shuttle. But management typically assessed the risk of a catastrophic failure as one in thousands or less. Until, on 28 January 1986 the space shuttle was launched in precipitously cold weather, which led to the explosion of the shuttle and the death of seven astronauts. No wonder the engineering culture in Germany emphasises the risks of a partial education.

The relationship between overconfidence and expertise