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Speaker: At some point, almost everyone has made an investing mistake that they kick themselves for later. The good news is that many of these mistakes can be prevented according to Michael Mauboussin, chief investment officer at investment shop, Legg Mason. Informally, he's known as Legg's resident philosopher. He's also the author of a new book about decision-making called "Think Twice." Hi, Michael. Thanks for joining us.
>> Michael Mauboussin: Hey, Jack, Great to see you.
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Speaker: Now, obviously, if people knew they were making a bad decision, they'd change the process. How can you catch yourself in the act, if you will?
>> Michael Mauboussin: Well, the main idea of this book is that when we face certain types of problems, our mind is gonna naturally take us down one path when a better way to think about it is a different way. So what we try to do in this book is specifically gave -- provide those situations -- there are eight of them altogether -- recognize that they're gonna show up in different guises, and then specifically show how to apply methods to try to mitigate it. I'll give you one very quick example, something that's called the inside versus outside view. When we solve problems, we typically use the inside view. That means we gather information. We use our own inputs. And then we figure it out. There's a much better way to do that. It's called the outside view, which is asking a really simple question. When other people have been in this situation, what has happened? And it turns out, if you think about the outside view, it opens up all sorts of statistical data that allow you to make much better decisions going forward.
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Speaker: One thing to talk about is collective wisdom. And sometimes -- not always -- sometimes collective wisdom can really nail it. Can you give some examples?
>> Michael Mauboussin: Absolutely. It turns out the wisdom of crowds works when three conditions are in place. We need diversity, so people that are thinking differently, aggregation, a way to bring information together, and properly functioning incentives. When those three things are happening, everything runs great. But when one or more of those conditions are violated, we get massive inefficiencies in the world. The best thing is almost always diversity. Rather than each of us thinking differently, we all start to coordinate our behaviors. We become unduly bullish, inaudible --
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Speaker: Group think.
>> Michael Mauboussin: Group think. Absolutely. And by the way, this is been around as long as there have been markets. And this, too, is a tip-off for investors to think about. If you're feeling really good, or you're feeling really depressed, often your emotions are taking you down the wrong path.
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Speaker: So you've got to give the jellybean example. I love that one.
>> Michael Mauboussin: Exactly. Well, this is something I do with my class up at Columbia Business School every year. I hand out a jar of jellybeans, and I say, "Guess how many beans are in the jar." Well, when you tally it all up, the group -- the average of everybody is actually incredibly accurate. But if you look at any individual, they're way off, in fact, by about 60 percent. So it's really the canceling out of the errors that allows us to get a very clear answer. So that's a great example where diversity, aggregation -- which is me counting up the jar -- the beans in the jar, it gives me a very, very efficient answer.
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Speaker: So if any individual is likely to be off by 700 jellybeans, why should viewers listen to you? Why should they read "Money Watch" and take our advice?
>> Michael Mauboussin: That's a fair question. We have a whole chapter dedicated to the -- where experts don't do very well. And where experts actually don't predict very well is things like financial markets or political outcomes. So you have to be very cautious -- and the record of experts predicting, by the way, is really bad. What -- what should you do about that? Well, the answer is, for most people, probably indexing. Passive investment problem does make a lot of sense.
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Speaker: I'm glad you like that because we recommended all the time. One thing it helps you avoid is buying high in selling low. Can you explain how to just get that out of your decision making process because we know so many people fall prey to that problem. We just saw it in action.
>> Michael Mauboussin: Exactly. This is a huge one. In any system that has skill and luck combined, you're gonna have this idea of mean reversion. And I think people understand that skill and luck combine in the outcomes they see. For example, in the World Series there's going to be a lot of luck in all these outcomes. But people have a hard time calibrating the relative contributions. So what happens when that happens is when you see really good outcomes, it's some skill and typically a lot of good luck. And really bad outcomes is a lot of bad luck, and things tend to mean revert. So what happens, even for institutions, very sophisticated people, is they tend to want to buy funds that have done really well, that have been really lucky, and they do. And then they want to sell the funds that have done really badly, and of course, in the subsequent periods, you see that mean reversion. The funds that they sold do better than the ones that they bought. So as an investor, be very mindful. Extreme outcomes are almost always going to mean revert.
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Speaker: So as an investor, what should I do? Always hold on to the bad ones and sell the good ones?
>> Michael Mauboussin: Great question. I always call it a two-step process. First is think like a contrarian. And I want to be clear; being a contrarian all the time is not a good idea. If the movie house is on fire, run out the door for heaven's sakes, right? But first think about what everybody seems to be believing at a particular time. And the second thing is then check the difference between fundamentals and expectations. Expectations is what it's built into the asset prices, for example, a stock. And the fundamentals is how is that company gonna perform? And when you start to see mismatches between those two, that's where you start to have an investment opportunity out of the market. Again, it's too optimistic or too pessimistic. So think contrarian and test fundamentals verses expectations. That's the one-two step to take advantage of it.
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Speaker: Michael Mauboussin, thank you.
>> Michael Mauboussin: Thanks, Jack.
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Speaker: And thanks for watching.
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==== Transcribed by Automatic Sync Technologies ====
