In yesterday’s essay, I introduced you to Michael J. Mauboussin, a prominent value investor, author, and longtime adjunct professor at Columbia University.[ad#Google Adsense 336×280-IA]Mauboussin estimates he has devoted two-thirds of his 30-year investing career to thinking and writing about the investment process. Last summer, he condensed those two decades of insights and analysis into an essay titled “Reflections on the 10 Attributes of Great Investors.”
Yesterday, we reviewed five of those attributes. Today, we’ll explore the remaining five…
6. “Beware of behavioral biases (minimizing constraints to good thinking).”
The way we think and feel directly affects our investment behavior and “biases” our decision-making process. Robert P. Seawright, a successful money manager and author, considers what I’ve summarized below to be some of the most common behavioral biases for investors:
- Confirmation Bias: It’s a tendency to reach a conclusion first, then gather data that “confirm” this preconception.
- Loss Aversion: Investors are twice as likely to be influenced by the pain of a loss than the enjoyment of a gain. This favors inaction over action, even when the facts suggest otherwise.
- Choice Paralysis: Information overload fosters indecision.
- Herding: Following the crowd, even if the facts suggest you shouldn’t. Warren Buffett refers to this as the “institutional imperative,” a tendency of money managers to follow the actions of their peers, even when it makes no sense.
- Recency Bias: Notable short seller and money manager Scott Fearon calls this “historical myopia,” a tendency to assume the recent past is a better predictor of the future than the distant past.
- The Bias Blind Spot: This is our inclination to believe we aren’t susceptible to the preceding behavioral biases that plague everyone else.
Mauboussin believes great investors are generally less affected by these behavioral biases because they acknowledge the existence of these biases, learning how to cope with them. They create a working (investing) environment that helps them “think well.”
7. “Think probabilistically (there are few sure things).”
The late Amos Tversky was a brilliant mathematical psychologist and author of highly regarded works on behavioral economics. Philip E. Tetlock, in his excellent book, Superforecasting: The Art and Science of Prediction, recalls Tversky telling him that most people only have three probability settings: “gonna happen,” “not gonna happen,” and “maybe.”
If you aspire to investing greatness, this three-setting dial won’t cut it. As Mauboussin says, superior returns come from constantly seeking an edge “where the price for an asset misrepresents either the probabilities or the outcomes.”
Superforecasters – a group of ordinary folks who consistently out-forecasted their peers in the U.S. intelligence community – routinely demanded far greater granularity of themselves. The lesson they teach us is this: Your edge comes from digging so deeply into the problem at hand that you understand the finer-grained issues – and how they’re likely to influence the outcome.
8. “Update your views effectively.”
Mauboussin says great investors do two things that most of us do not: 1) They seek out information and/or views different from their own, and 2) they update their beliefs when the evidence suggests they should.
As he puts it: “Beliefs are hypotheses to be tested, not treasures to be protected.”
9. “Position sizing (maximizing the payoff from edge).”
It’s easy to forget that there are two aspects to superior returns: finding an edge, then exploiting it with proper position sizing.
If you develop a strong conviction for a particular investment but don’t size it accordingly, you’re not maximizing the potential payoff from your edge. That’s why, in Extreme Value, we recommend subscribers allocate higher proportions of capital to our highest-conviction picks.
10. “Read (and keep an open mind).”
Berkshire Hathaway’s Charlie Munger says it best: “In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero.”
Many successful people make reading a priority. If you aspire to investing greatness, you should, too.
Every investor, novice or pro, should aspire to realize Mauboussin’s 10 attributes. If you aspire to be a great fundamental investor, consider this your trusted playbook.
Source: Daily Wealth