Michael Mauboussin, director of research at BlueMountain Capital Management, discusses the five most common behavioral mistakes he sees investors make. He explains what scientific research can teach us about investor behavior, and discusses how the types of mistakes made can shift over the course of an economic and market cycle. With this background set, Mauboussin provides tips for plugging one’s behavioral leaks. Finally, he explains how one might be able to make better decisions by anticipating the mistakes of others. Filmed on January 25, 2018 in New York.
Five Common Behavioral Mistakes Investors Make With Michael Mauboussin – Expert View – Real Vision
Think about where you can gain advantage in markets it tends to be getting some sort of informational edge which has become increasingly difficult having some sort of an analytical advantage which is really hard. But the big one is really behavioral and what we know is most inefficiencies come from market or many inefficiencies that go for market are often from behavioral failures. So it's I think probably if not the largest. Certainly one of the largest sources of opportunities in one of its largest sources of failures. First is it is really important to try to minimize your own mistakes and that is typically trying to identify what kinds of biases you're likely to have are all kinds of mistakes you're likely to make. And then to try to minimize those as well as possible. And the second is of course if other people are going to make those mistakes those will present opportunities and you don't want to be shy to try to take advantage of those. I'll tell you one interesting side story on this there was a really great interview with a tool Gawande who was a surgeon up in Boston and he told of a paper he read about mistakes that doctors makes a physicians make and we'll bring this back to investing in a second and he said there are basically two different categories.
The first category is called ignorance right. We just don't know what medicines will make people better or we don't know how to do this particular surgery. And of course reducing that ignorance is great. And that's what a lot of billions of dollars and ARDE go to do. But the second kind of mistake which is probably more prevalent and probably even more costly is that people don't do what they know they're supposed to do. So physicians may not wash their hands or do certain protocols before surgeries or whatever it is and that's much more pedestrian and the doctors know how to do it. They just don't always do it and I think the same kind of thing applies in investing a lot of it is just doing the things that we know that we're supposed to do thinking about all the different outcomes weighing things intelligently and again trying to be aware of and to manage and mitigate all those biases. So I think there are both sets of opportunities reducing errors finding other people errors.
But you have to think about both ways.
The first mistake is a failure to use base rates. And I really think this lesson I got from Danny Kahneman of course very famous psychologist who won the Nobel Prize in economics and here's the basic setup there's this idea called the inside view and the outside view which is base rates the inside view says when I'm posed with a problem can be almost any kind of problem. The classic way to deal with it and see if this makes sense to write is to gather lots of information combine it with your own inputs and experience and then project into the future. So for example if I say analyze this company you'll gather lots of information you'll build a model based on your inputs and your experience and that'll reveal what you think is going to happen. The outside view by contrast which relies on base rate says I'm going to think about my problem it's an instance of a larger reference class Gonesse question what happens when other people are in the situation or if you're modeling a company. What happened when other companies were in this situation before.
I want to underscore it's a very unnatural way to think for a couple of reasons. First is you have to leave aside all of this cherish information write your own experience which we tend to place a lot of value on. And second is you have to find an appeal to this base rate which may not be at your fingertips. Let me give you one example to try to make this slightly more concrete. But a year ago a little less than a year ago. The economists had a cover story onamazon.com right. This company is really doing great taking over the world. And then there was the analyst said We think that Amazon will grow revenues 15 percent a year compounded annually for the next 10 years. Now at the time it had revenues already over 100 billion dollars. Now I'm sure that analysts if you sat down with him or her would have this awesome model going through all the different businesses and a very convincing overall narrative. The question at the outset you would ask are the base rates would ask is how many companies have ever grown at that rate of that size in history. And the answer is it's never been done at least not since 1950 we look at all the companies back to 1950. Inflation adjust their revenues and look at their growth.