Tom Gardner Interviews Michael Mauboussin
Board: Macro Economics
Tom Gardner interviewed Michael Mauboussin, chief investment strategist at Legg Mason Capital Management. I have been reading Michael’s papers for many years and always learn something from them.  The interview is excellent and worth your time IMO. You can either listen to it and/or read the transcript at the link.
Instead of attempting to summarize the entire interview, I have picked out one section that is the top takeaway for me. If we did these three things, it would likely improve our investment results.
Gardner: So step one, to improve their quality of decision making would be a decision-making journal. Can you explain...?
Mauboussin: Yeah, this is great. Many years ago when I first met Danny Kahneman, and Kahneman is one of the preeminent psychologists in the world who won a Nobel Prize for economics in 2002, even though he's never taught an economics class.
When I pose him the question, what is a single thing an investor can do to improve his or her performance, he said almost without hesitation, go down to a local drugstore and buy a very cheap notebook and start keeping track of your decisions. And the specific idea is whenever you're making a consequential decision, something going in or out of the portfolio, just take a moment to think, write down what you expect to happen, why you expect it to happen and then actually, and this is optional, but probably a great idea, is write down how you feel about the situation, both physically and even emotionally. Just, how do you feel? I feel tired. I feel good, or this stock is really draining me. Whatever you think.
The key to doing this is that it prevents something called hindsight bias, which is no matter what happens in the world. We tend to look back on our decision-making process, and we tilt it in a way that looks more favorable to us, right? So we have a bias to explain what has happened.
When you've got a decision-making journal, it gives you accurate and honest feedback of what you were thinking at that time. And so there can be situations, by the way, you buy a stock and it goes up, but it goes up for reasons very different than what you thought was going to happen. And having that feedback in a way to almost check yourself periodically is extremely valuable. So that's, I think, a very inexpensive; it's actually not super time consuming, but a very, very valuable way of giving yourself essential feedback because our minds won't do it normally.
Gardner: The second one is a checklist, an investment checklist. What does that consist of?
Mauboussin: So the best work on this I've seen is by Atul Gawande, who is a surgeon in Boston who wrote a book a couple of years ago called The Checklist Manifesto, and one of the points he makes in there is that when you go from field to field, wherever checklists have been used correctly and with fidelity, they've been extremely effective in proving outcomes. So we all know none of us would step on an airplane today without the pilot having gone through the checklist. It's been a big move into medicine, especially for example, in surgery where checklists have really made substantial inroads in reducing infections, for example, and hence mortality, and other areas like construction elsewhere.
So the question is, how do you become more systematic in applying what you know? And I'll just mention one other thing on this. There are two; Gawande talks about two kinds of checklists. By the way, this branch is right out of aviation. One is called a do-confirm checklist, a do-confirm, and that just basically says, Hey, just do your normal analysis the way you've always done it and been trained to do that, but stop periodically just to confirm that you've covered all the bases. So as an analyst that might say, hey, I'm going to do a really thorough evaluation work. I might look very carefully at return on capital trends. I might study the competitive strategy position. You are just going to do all that stuff, but you're going to stop every now and then, just to check to make sure you've done everything.
The second one is called, the second kind of checklist, is called a read-do checklist. This is when you get into a difficult situation, for example you're a pilot and one of your engines goes out, the redo will guide how you should approach that problem. So you don't have to think about it so much, you just sort of go through it systematically. And so for an investor that might be hey, what happens when a company misses a quarter? What happens when they have a negative announcement or an executive departure? Sometimes that means sell the stock. Sometimes that means buy more. Sometimes it means do nothing, and a read-do checklist can help guide some of that thinking as well. So it's really a way to be structured and consistent in your analysis.
Gardner: The third one actually, the pre-mortem, I love; we used to, on our NPR radio show, play a game entitled What Went Wrong? And we [unclear] incredibly popular stock in company, and announce to our audience, "This stock falls 50% over the next five years. What went wrong?" So tell us about the pre-mortem.
Mauboussin: Yeah, so most people are familiar with a post-mortem, right?
Which is a play off the same words, and a post-mortem is we bought this stock and it went down, so let's get around the table, talk about why we made the decision, how we got it wrong, as you pointed out, and see if there's lessons that we can glean from that. And again, post-mortems are very popular in different disciplines.
A pre-mortem, and this idea, by the way, was developed by a social psychologist named Gary Klein. He has a very different concept. He says before we actually make the decisions, so we've not put any money to work yet. Let's launch ourselves into the future, and let's just say it's July 2013, a year from now. Let's say that we made the investment and it turned out badly. Now each of us independently should write down on a piece of paper, or maybe even write a little article about what went wrong.
And it turns out when people go through that exercise, they are able to identify up to 30% more factors or variables than they would just standing in the present looking to the future. So somehow this idea of extracting yourself, putting yourself into the future looking back to the present, opens up your mind a little bit versus standing in the present and looking into the future. And it's a funny thing because you can think about all sorts of predictions people have made about the world, about whatever it is, about energy prices, gold prices, economic growth, what have you, and you can see it's very difficult to anticipate what's likely to happen, so pre-mortem can help open up your mind and get you to contemplate or evaluate these variables.
The quoted section is longer than I would normally post, but it is maybe 10% of the overall interview. Instead of learning and acting on 100%, if we only act on this 10%, I think it will help.
I am a big believer in post-mortem’s aka autopsies. I spent many years as a coroner, not of humans, but of “processes.” I attempt to autopsy every trade that does NOT perform as planned. I try to burn these investing mistakes into the forefront of my brain and hopefully prevent making the same mistakes again. If you do NOT know what you did wrong, it makes it very difficult to prevent it in the future.
Related to the Ben Bernanke-Richard Fisher-FOMC discussions, my number one criticism of the FED is that they have NOT published an autopsy of “What killed the economy, what we did wrong and how we are going to prevent it in the future.” They have over 200 PHD economists on staff, but for some reason do not see fit to publish this white paper. The feedback I keep receiving is along the lines of “We saved the financial world, post crash, therefore our correct actions swamp our incorrect actions.”I have talked about it so much my orange skin has turned blue, all to no avail.
We might not, make that CANNOT, influence if the Fed performs post-mortems, but we can make that decision individually. I strongly recommend it as a worthwhile exercise.
PS: Nobody at the Fool had any input on this post not was I prompted to write it.
 Tom Gardner interview with Michael Mauboussin
 Michael Mauboussin papers