Ignorance, Risk, and Uncertainty - Knowing our limitations

Hat tip to abnormal returns for the discussion of ignorance, uncertainty and risk with respect to BP.

We are slaves to our ignorance. At the extreme we may be too stupid to know we are stupid, so we have to know our limitations or as stated by Dirty Harry, "I like a man who knows his limitations".

The Dunning-Kruger effect:

When people are incompetent in the strategies they adopt to achieve success and satisfaction, they suffer a dual burden: Not only do they reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the ability to realize it.

Errol Morris opinion blog in NYT

Put simply, people tend to do what they know and fail to do that which they have no conception of. In that way, ignorance profoundly channels the course we take in life. And unknown unknowns constitute a grand swath of everybody’s field of ignorance.

To me, unknown unknowns enter at two different levels. The first is at the level of risk and problem. Many tasks in life contain uncertainties that are known — so-called “known unknowns.” These are potential problems for any venture, but they at least are problems that people can be vigilant about, prepare for, take insurance on, and often head off at the pass. Unknown unknown risks, on the other hand, are problems that people do not know they are vulnerable to.

A “known unknown” is a known question with an unknown answer. I can ask the question: what is the melting point of beryllium? I may not know the answer, but I can look it up. I can do some research. It may even be a question which no one knows the answer to. With an “unknown unknown,” I don’t even know what questions to ask, let alone how to answer those questions.

David Dunning, in his book “Self-Insight,” calls the Dunning-Kruger Effect “the anosognosia of everyday life.” When I first heard the word “anosognosia,” Anosognosia is a condition in which a person who suffers from a disability seems unaware of or denies the existence of his or her disability.

Donal Rumsfeld has set the standard for discussion son these issues.

“There are things we know we know about terrorism. There are things we know we don’t know. And there are things that are unknown unknowns. We don’t know that we don’t know. "

"All of us in this business read intelligence information. And we read it daily and we think about it, and it becomes in our minds essentially what exists. And that’s wrong. It is not what exists.”

Knowing what we do not know is relevant for investing. If the market is moving up and you don't know why you have to accept that there is something unknown to you.