How to stop yourself before you make another costly decision.
Warren Buffett once famously said: “Virtually all surprises are unpleasant.” In a world where surprises have become the norm, scenario planning, forecasting and thinking are among the best skills that businesses can engage.
Author and chief investment strategist at Legg Mason Capital Management, Michael J Mauboussin believes no one intentionally makes bad decisions, but despite this, we make poor choices all the time. In fact, some of the worst economic disasters in recent history - the collapse of major investment banks, the global financial meltdown - were the result of seemingly reasonable decisions made by a lot of smart people.
“History contains plenty of examples of intelligent people who made poor decisions, with horrific consequences.” - Michael J Mauboussin
In his book, Think Twice: Harnessing the Power of Counterintuition, Mauboussin argues that the correct process for deciding well - especially when the stakes are high - conflicts with how our minds naturally work. When faced with complex situations, our brains revert to simplified patterns that obscure better approaches to the problem. Even when we think we're applying logic and reason, we're subconsciously succumbing to social or situational influences. Fortunately, we can override our mind's default systems - that is, we can counter our intuition - by learning to “think twice”.
“Smart people make poor decisions because they have the same factory setting on their mental software as the rest of us, and that software isn't designed to cope with many of today's problems.” - Michael J Mauboussin
Mauboussin outlines a disciplined approach to decision-making that will significantly reduce costly mistakes. It involves preparing to encounter common mental traps, recognising these mistakes in context, and applying the right mental tools to shape better decisions.
The author of three books, including More Than You Know: Finding Financial Wisdom in Unconventional Places, named in the 100 Best Business Books of All Time by 800-CEO-Read, Mauboussin has been an adjunct professor of finance at Columbia Business School since 1993, and received the Dean's Award for Teaching Excellence in 2009.
Book abstract - Think Twice by Michael J Mauboussin
Even gullibility experts can be duped
Psychology professor Stephen Greenspan's book: Annals of Gullibility: Why We Get Duped and How to Avoid It, hit the bookstores in December 2008, the month that Bernard Madoff's Ponzi scheme became public and cost gullible investors more than $60 billion. Greenspan was one of Madoff's investors; he lost nearly a third of his retirement savings. Later, Greenspan stated that the attraction of a return on investment “that looked, in retrospect, too good to be true” had clouded his thought processes. Greenspan's case is not uncommon. Smart, well-informed people make decisions as poorly as anyone else.
The human mind is not hard-wired for rational thinking, and many intelligent and creative people harbour false beliefs. Arthur Conan Doyle, the creator of the super-rational detective Sherlock Holmes, believed in spiritualism and fairies. His capacity to interpret the world accurately was therefore rather less than that of his protagonist. To make better decisions, learn to “think twice” to counteract false premises and avoid other mental pitfalls. Don't go with your first impulse. Instead, slow down and take these three steps:
1. “Prepare” - Learn about the kinds of mistakes you and other people make. Study botched decisions.
2. “Recognise” - Identify the type of problem you confront, what the risks of a poor decision are and “what tools you need to choose wisely”. People often attempt to apply simple solutions to complicated problems. Analyse your problem's context.
3. “Apply” - Train your mind, the way athletes train their bodies. Often this requires “keeping your intuition in check”.
The outside view
In 2008, Big Brown, a three-year-old racehorse, was a heavy favourite to win the Triple Crown, which honours horses that win the Kentucky Derby, the Preakness Stakes and the Belmont Stakes - races that take place over a short, five-week period. Big Brown had already won the first two and he was up against negligible talent in the Belmont Stakes. Thus, many bettors saw Big Brown as a shoo-in for that race and the Triple Crown. “It's a foregone conclusion,” said Rick Dutrow, the horse's trainer. He should have done some more concluding. Big Brown came in last.
Instead of relying on anecdotal evidence, the handicappers should have studied how previous double winners had performed in the Belmont Stakes - badly - and should have considered Big Brown's “Beyer Speed Figure”. This analysis evaluates a horse's performance based on its race times and individual track speeds. Big Brown's figures were unpromising.
Even when we think we're applying logic and reason, we're subconsciously succumbing to social or situational influences.Mandy de Waal, ITWeb contributor
If you judged him by the “inside view”, Big Brown's previous victories and impressive appearance made him the likely winner. If you judged him by the “outside view”, though, and compared his situation with similar ones, you could have predicted that he was a likely loser.
Don't let “close-at-hand information” lead you astray. Avoid the inside view. Your problems are not unique. Use objective information about how other people have evaluated and handled the type of problem you face. Study the decisions of this “reference class” - other individuals in circumstances similar to yours. Note the “distribution of outcomes” - the rates of success versus failure.
Humans tend to be overly optimistic. If you must forecast something that is inherently difficult to predict, for example, movie attendance or book sales, “adjust your prediction” to the most “relevant statistical measure”.
Open to options
If you ask someone to jot down the last four digits of his or her phone number and then to guess the number of doctors in New York City, the estimate will be significantly higher for people whose phone number digits represent a higher number than for those with a lower number. The reason for this strange result is that when people must guess a number, they start with an “anchor.” They adjust their guess according to the information that's closest at hand. People will grab any anchor, even if it has nothing to do with the question.
Avoid the “tunnel vision trap” by seeking out different points of view. Don't make important decisions at stressful times. Since incentives can sway your opinions, analyse the incentives that might cause you to make one decision or another. Consider the potential consequences of your actions.
Keep a “decision-making journal”. Enter each major decision you make into this log, the reasons that led to your choice, a description of your mood and your prediction of the outcome. By auditing your decisions, you'll be able to evaluate them. The journal will reveal patterns in your thinking. With a record of your decisions, you will avoid “hindsight bias”, the inclination to see events as more predictable than they were. It will help you remember how the situation presented itself to you before you knew its outcome.
Think Twice: Harnessing the Power of Counterintuition
By Michael J Mauboussin
Format: Hardcover Publisher: Harvard Business School Press
Publication date: October 2009