Michael J. Mauboussin: Part 2 of an interview by Bob Morris

Mauboussin-Michael-175x116Michael J. Mauboussin is Chief LMCM in 2004, Michael was Chief U.S. Investment Strategist at Credit Suisse. Michael joined CS in 1992 as a packaged food industry analyst, and was repeatedly named to Institutional Investor‘s All-America Research Team and The Wall Street Journal All-Star survey. He is the author of The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (Harvard Business Review Press, 2012), Think Twice: Harnessing the Power of Counterintuition (Harvard Business Press, 2009) and More Than You Know: Finding Financial Wisdom in Unconventional Places, Updated and Expanded Edition (Columbia Business School Publishing, 2008). More Than You Know was named one of “The 100 Best Business Books of All Time” by 800-CEO-READ. He is also co-author, with Alfred Rappaport, of Expectations Investing: Reading Stock Prices for Better Returns (Harvard Business School Press, 2001).

Michael has been an adjunct professor of finance at Columbia Business School since 1993 and is on the faculty of the Heilbrunn Center for Graham and Dodd Investing. In 2009, Michael received the Dean’s Award for Teaching Excellence. He earned an A.B. from Georgetown University. He is also chairman of the board of trustees of the Santa Fe Institute, a leading center for multi-disciplinary research in complex systems theory.

Here is an excerpt from Part 2 of my interview of Michael.

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Morris: Now please shift your attention to Think Twice. You seem to be convinced — and I agree — that most of the worst decisions are made in haste, without sufficient information, are driven by emotion rather than by reason, and are avoidable. If so, then almost anyone can avoid making such mistakes. True?

Mauboussin: Well, it’s easier said than done. But understanding the types of situations that lead to mistakes is the first step toward managing or mitigating them.

The basic point of the book is that when faced with certain types of situations, our minds will naturally think about the problem one way when there’s a better, more correct, approach. Danny Kahneman’s two systems of the mind are one way to think about it. System 1 is your experiential system. It is fast, automatic, and difficult to train. System 2 is your analytical system. It is slow and purposeful, but malleable. Kahneman’s point is that System 1 generally throws up answers that are right, and System 2 goes along. In certain cases, for example if I ask you to multiply 2,367 times 5,981, you need to recruit your System 2 to answer the problem. You can do it, it’s just you can’t do it automatically.

Think Twice is about situations where System 1 throws up answers that are wrong. Without recruiting System 2, you’ll answer incorrectly. So the idea is to learn about these kinds of situations and have a sense of when you need to slow down and recruit System 2.

There’s a very simple example of how this works. Ask the following question:

A bat and ball together cost $1.10. The bat costs $1.00 more than the ball. How much does the ball cost?

If you’re normal, your System 1 shouted an answer in your mind: ten cents. Most people, indeed, answer ten cents. But, of course, that’s wrong. ($0.10 + $1.10 = $1.20) The answer is five cents. Now this is elementary arithmetic, and certainly no challenge. But the structure of the question elicits a quick, incorrect response. My argument is that these kinds of situations are out there and you need to learn to deal with them.

Morris: Here’s one of several passages that caught my eye: “Smart people make poor decisions because they have the same factory settings on their mental software as the rest of us, and that software isn’t designed to cope with many of today’s problems…Beyond the problem of mental software, smart people make bad decisions because they harbor false beliefs.” What to do?

Mauboussin: I argue for three steps: prepare, recognize, and apply. Prepare means that you should learn about the situations and create a mental database of them. In each case, I attempt to clearly identify the situation and explain the science behind it. Recognize acknowledges that these possible mistakes will show up in different guises in your life. You’ll see them in your personal life, your professional life, while watching the news or taking in a ballgame. Apply is about knowing how to deal with the situations so as to slow your process and bring in System 2. Each chapter ends with some concrete action steps you can take to improve your decisions.

Morris: Here’s another. You make no claim to immunity from various cognitive mistakes and duly acknowledge, “I still fall for every one I describe in the book.” You state that your personal goal, when making a choice, “is to recognize when I enter a danger zone while trying to make a decision and to slow down when I do. Finding the proper point of view at the appropriate time is critical.” Here’s a two-part question. First, What are the defining characteristics of the “danger zone” to which you refer?

Mauboussin: A danger zone is when you’re in one of these situations and the decision at hand is consequential. So the first step is being aware of the situation. But even then it’s not a big deal unless the decision is important.

Morris: How best to determine, when approaching or entering one, whether or not a point of view is proper and the timing is right?

Mauboussin: I’m not sure there’s a great answer save being mindful of the circumstances of your decision. Let me give you an example. One of my neighbors read the book and was immediately faced with a situation that dealt with the inside versus outside view. The inside view says that when we decide, we tend to gather information about the situation, combine it with our own inputs, and decide. The outside view considers the problem as an instance of a larger reference class. It basically asks: when other people were in this situation, what happened?

It turns out that people frequently rely too much on the inside view and fail to properly consider the outside view. My neighbor’s situation was a financial proposition. The little voice in his head told him to follow the inside view, which would have entailed an investment. The outside view suggested the investment was not a good idea. He stopped, thought about it, and decided to forgo the investment. It turned out it saved him a tidy sum. There’s a good example. My neighbor was prepared to understand the issue, recognized it in context, and applied the approach to come to the correct decision.

Morris: What is the “halo effect”? Why and how specifically can it create problems?

Mauboussin: The halo effect was a term coined by a psychologist named Edward Thorndike and was popularized in recent years by Phil Rosenzweig through his excellent book, The Halo Effect. The basic idea is than when we observe success or like something, we attach impossibly good attributes to it. When we observe failure or dislike something, we see nothing but bad attributes.

For instance, Thorndike studied how officers rated their men in the military. If the officer liked a specific solider, he scored him high across all measures, including physical abilities, intellect, discipline, etc. The overall impression dominated the scores for individual attributes.

This creates problems because we tend to think successful companies or individuals are better than they really are, and fail to anticipate reversion to the mean.

Morris: As a father of four and one of the grandfathers of their ten children, I feel a constant temptation to offer advice whenever one of the older ones must make an especially important decision. In your opinion, should someone such as I “think twice” before volunteering advice? Also, to what extent (if any) will someone be willing to accept unsolicited advice from an elder?

Mauboussin: As a father of five kids, I hear you! My policy is to never give advice. I only provide recommendations. Basically, I try to point out the danger zone as I see it and try to slow down the process. I might then offer some thoughts on how to deal with the problem. By walking through the process versus simply getting to the answer, I’m hoping to be able to teach my kids to walk through the process on their own. A recommendation often falls out of the process, which may be roughly equivalent to “advice.” But I try to emphasize the process of making the decision versus solely getting to the answer.

* * *

Here is a direct link all of Part 2.

To read Part 1, please click here.

Michael cordially invites you to check out the resources at these websites:

His website

His Amazon page

His Columbia Business School faculty page

His Santa Fe Institute page

A “foolish interview” by The Motley Fool

YouTube program link

You can also follow him at Twitter



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