C&B Notes

Fooling the Man in the Mirror

Richard Feynman was right, “…you must not fool yourself and you are the easiest person to fool.”  We think a lot about the cognitive biases that can cause us to make poor decisions, and we have intentionally structured our funds with a two-portfolio-manager framework.  Being willing to constructively challenge one another helps prevent us from holding hands and walking off of a cliff together.

These behavioral and cognitive biases (plus many more) constantly conspire to limit our ability to make good investment decisions.  Fortunately, behavioral economics has done a terrific job at providing an outline as to what these risks look like.  But it is one thing to recognize these cognitive difficulties, of course, and quite another actually to do something about them, as Kahneman concedes.  Recent evidence even suggests that being smarter, more aware or more educated doesn’t seem to help us deal with these cognitive difficulties more effectively.  Indeed, they may actually make things worse. For example, a new study suggests that, in many instances, smarter people are more vulnerable to thinking errors, even basic ones.  Moreover, “people who were aware of their own biases were not better able to overcome them.”  Indeed, we even know from neurobiology that when presented with evidence that our worldviews are patently false, we tend to refuse to engage the prefrontal cortex, the very part of the brain we need most to make sense of the new.

Accordingly, if we’re to have any chance of making good investment decisions consistently, we need help.  We need to construct personal and corporate investment processes that are robust to the various behavioral and cognitive foibles that beset us.  There are a number of possible ways to do that, although none is anything close to fail-safe. Among the possibilities are:

    • making sure every decision-maker has positive and negative skin in the game;
    • focusing more on what goes wrong and why than upon what works (what Harvard Medical School’s Atul Gawande calls “the power of negative thinking”);
    • making sure your investment process is data-driven at every point;
    • moving and reading outside your own circles and interests;
    • focusing on process more than results;
    • collaborating — especially with people who have very different ideas (what Kahneman calls “adversarial collaboration”);
    • building in robust accountability mechanisms for yourself and your overall process; and
    • slowing down and going through every aspect of the decision again.

One additional (and related) suggestion worth special focus is that in order to improve our chances of success, we need both outside input and an “outside view.”  As Kahneman noted during a presentation I attended, our best chance of overcoming our inherent biases is for us to ask the best and smartest people we know to tear our ideas apart.  In other words, the best advice is to “[s]low down, sleep on it, and ask your most brutal and least empathetic close friends for their advice.”  We also need what Michael Mauboussin calls the “outside view.”  It requires that we expand the reference class beyond our comfort zone and our personal experience.  We need a much bigger sample size from which to acquire data.  In essence, we need an empowered devil’s advocate.

Per Kahneman, organizations are more likely to succeed at overcoming bias than individuals.  That’s partly on account of resources, and partly because self-criticism is so difficult.  The best check on bad decision-making we have is when someone (or, when possible, an empowered team) we respect systematically sets out to show us where and how we are wrong.  Within organizations that means making sure that everyone can be challenged without fear of reprisal and that everyone (and especially anyone in charge) is accountable.