THINK TWICE

Harnessing the Power

of Counterintuition
MICHAEL MAUBOUSSIN

MICHAEL MAUBOUSSIN is chief investment strategist at Legg Mason Capital Management. He has been
adjunct professor of finance at Columbia Business School since 1993. Mr. Mauboussin has served as
managing director of Credit Suisse and is the former president of the Consumer Analyst Group of New York.
Mr. Mauboussin is the author of More Than You Know and the coauthor of Expectations Investing. He is a
graduate of Georgetown University.
Mr. Mauboussin’s Web site is at www.MichaelMauboussin.com.

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 Think Twice - Page 1

MAIN IDEA
Why do smart people sometimes make appalling bad decisions, especially when the stakes are high? It really comes down to the
mental software hardwired into the human brain. We genuinely are not well equipped to deal with many of today’s most pressing
problems. We see the world we want to see rather than letting the facts speak for themselves. We also have no problems harboring
false beliefs, even if irrational. And most of us would rather do whatever comes to mind first rather than properly calibrating the
evidence which lies at hand and applying that to our decision making.
To reduce the number of mistakes you make, try and think twice about your choices. To do that, three steps are involved:

Learn about the mistakes Build and then use mental

others have made in the past so tools which will help you prevent
you can avoid them falling into any traps

ý Poor
Decisions Prepare Recognize Apply
þ Great
Decisions

Recognize the problem at

hand in its proper context and
allow for all the risks

The eight most common decision mistakes – and how to offset them . . . . . . . . . . . . . . . . . . . . . . Pages 2 - 7

Mistake Solution

Incorporate an outside view in every decision you

1 We all like to think our problems are unique rather than
make. Identify other people who have solved the
carefully considering the relevant experiences of others.
same problem and adapt what they did right.

Make a conscious decision to consider other

We all suffer from tunnel vision at times and fail to
2 alternatives and give voice to dissenters. And
adequately consider all the alternatives.
always know what incentives are involved.

Seek diversity and ensure you’re using the best

We want to rely on experts and like to believe they know
3 technology which is available. Remind yourself
more than they really do.
experts always have a very narrow focus.

Acknowledge decision making is an inherently

4 We don’t always act objectively but take our cues from
social exercise and therefore you need to manage
the behaviors of those around us.
the influences you feel. Watch out for group think.

Avoid focusing on just one part of the system and

We tend to look at complex systems and seek ways to
5 instead try to gain an appreciation of the overall
come up with a simplifying mental model.
system dynamics. If feasible, use simulations.

Acknowledge that circumstances can and do

We form inaccurate cause-and-effect relationships,
6 change constantly and there are no universal rules
especially for situations generated by circumstances.
which will apply at all times.

Be aware of the power and reach of coordinated

We’re not really familiar with tipping points where a small
7 behavior and be careful not to extrapolate the past
change can lead to major consequences.
into the future.

Evaluate the mix of skill and luck in the system

We overemphasize the effect our skill has on the result
8 you’re looking at and be careful about any
and minimize the impact of luck in our successes.
conclusions you draw which rely on luck.

How to improve your decision making immediately. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 8

 Think Twice - Page 2

3. Make a forecast – an estimate of your likelihood of success or

The eight most common decision mistakes failure. More than likely, your forecast will be wildly optimistic
– and how to offset them but that’s alright as long as you’re aware of that likely bias.
Figure out whether you can do something different which will
improve your chances of success. Determine whether
breaking from conventional wisdom will be helpful.
Poor Decisions ý 1
þ Great Decisions 4. Keep on assessing the reliability of your prediction and
fine-tuning – as more data comes to hand. Keep trying to
identify cause-and-effect relationships you can integrate into
We all like to think our Incorporate an outside view in
a better version of your forecast. More than likely, you will
problems are unique every decision you make.
need to end up adjusting your prediction towards the
rather than carefully Identify other people who have
long-term mean result.
considering the relevant solved the same problem and
experiences of others. adapt what they did right. “The main lesson from the inside-outside view is that while
decision makers tend to dwell on uniqueness, the best decisions
often derive from sameness. Don’t get me wrong. I’m not
Corporate mergers and acquisitions are a multi-trillion-dollar
advocating for bland, unimaginative, or risk-free decisions. I am
industry year after year. It’s not at all unusual for large
saying there is a wealth of useful information based on situations
corporations to spend millions identifying potential targets,
that are similar to the ones we face every day. We ignore that
carrying out acquisitions and then working to integrate those new
information to our own detriment. Paying attention to the wealth
companies into their operations. All of these acquisitions are
of information will help you make more effective decisions.”
made with the best of intentions but the reality is most
– Michael Mauboussin
transactions do not create value for the shareholders of the
acquiring company.

ý þ
Most executives acknowledge their chances of success in
creating value by making an acquisition are not good, but they Poor Decisions 2 Great Decisions
believe they can beat the odds. This is a prime example of
making decisions using an inside perspective alone. Executives We all suffer from tunnel Make a conscious decision
believe the synergies which will be created by combining the vision at times and fail to to consider other alternatives
companies will more than compensate for the premium the adequately consider all and give voice to dissenters.
acquiring company has to pay. There is the unstated belief the the alternatives. And always know the
acquiring company is getting more than it is paying for because incentives involved.
the executives know what they’re doing. Unfortunately for
investors, this usually turns out not to be the case at all.
To avoid falling into the trap of making decisions from an inside Most people start with a mental “anchor” when making a
perspective alone, the three-step process is: decision. An anchor is a first approximation of what you expect
the end result to be. It will be based on the model you expect to
Prepare Recognize Apply apply in this situation. When you have an anchor in place, then
you often end up with tunnel vision or a very narrow focus.
To illustrate:
n Prepare – look at how other companies have fared in making
acquisitions work for them rather than against them. n If someone were to ask you what the freezing point of vodka
is, you would probably start thinking about this by saying: “OK,
n Recognize – that you may be trying to move ahead on the the freezing point of water is thirty-two degrees Fahrenheit.”
basis of unwarranted optimism. That’s your mental anchor and you would then try and
n Apply – come up with a framework you can use to make better estimate whether you need to adjust upwards or downwards
decisions which incorporates all the available facts. Look for from water’s freezing point to reach vodka’s freezing point.
comparable situations which can provide a statistical basis for When a large group was asked this question, the mean
making a decision rather than viewing your problem as estimate was a reasonable twelve degrees but the correct
unique. It rarely is. answer is vodka freezes at minus twenty degrees.
So how do you incorporate an outside view into your decisions? n When a group of real estate agents were asked to appraise a
The specific steps involved are: house, they were given all given identical background
1. Select your reference data sample – a big enough group to materials except for one key point – the agents were given
be significant but narrow enough to be useful. It’s helpful if different listing prices for the same house. When they all came
your reference group is stable over time and not in an back with their appraisals, those who were given a higher
industry which is undergoing large-scale changes. listing price had valued the house for substantially more than
those who had been provided with a low listing price. The
2. Analyze and assess outcomes – figure out under which
agents were influenced by that starting point anchor, even
conditions success is more likely. For example, in the case of
though they believed they were making a completely
acquisitions, you may find when an acquisition is made using
independent and unbiased assessment of market price.
an all cash transaction and the premium paid is 5 percent or
less, then the deal is more likely than not to generate n In negotiations, the initial offer which either party makes can
synergies which add value. Look for patterns. have a strong effect on how the negotiation as a whole turns
out. This is very pronounced in ambiguous situations.
 Think Twice - Page 3

computers become more efficient at applying those principles

Prepare Recognize Apply repetitively and thoroughly. Experts are important initially to
figure out the rules but then computers come to the fore. One of
the keys in making great decisions is to differentiate when you
Anchors and mental models which result in tunnel vision are should be involving experts and when you’d be better off taking a
tricky because you’re not even aware you’re using them most of fresh approach.
the time. The incentives on offer can also generate tunnel vision
One area where this particularly applies is the ability of
as can extrapolating what happened in the past to project into the
computer-based systems to consolidate the best estimates of a
future.
large pool of people to forecast a future event. Various
To avoid the tunnel vision trap when making a decision: experiments have shown the collective wisdom of a crowd is
1. Explicitly list all available alternatives – those which are likely often more consistently accurate than using an expert.
as well as those which are highly unlikely. The mere fact you Computers are good at making collective judgments available
have a list of alternatives from which to choose will help you and accessible and it’s smart to use this approach to inject
move away from your preexisting anchor points. diversity into your own decision making.
2. Welcome dissent – even from people who are openly trying Of course a reasonable balance has to be struck. Relying solely
to prove you wrong. Be willing to engage in robust debate on computers and the collective wisdom of crowds to make
about the decision you’ve reached. Ask questions of those decisions is just as bad as relying exclusively on experts. Neither
who hold contrary opinions and listen carefully to what they’re approach warrants blind faith. You have to look at each decision
saying. If you appoint those with dissenting views to you’re making on its own merits and figure out which approach
prominent positions in your organization, you send the clear will enable you to make better decisions. There will be times and
signal clear thinking is required and welcomed. circumstances where experts will provide invaluable advice. In
other settings, looking at the wisdom of the crowd will be helpful.
3. Track your previous decisions – and see whether you
The trick is to know when to use either approach alone or a hybrid
consistently err on one side of the equation or the other.
combination of the two.
Humans have a strong “hindsight bias” where we believe we
knew more about the outcome beforehand than we actually To make experts work for you rather than against you:
did. To offset that, write down your decisions in a journal 1. Match the problem you’re facing with the solution which is
along with notes detailing the reasoning you applied. This will most likely to work – have a range of options rather than
encourage you to look at more alternatives. adopting a one-size-fits-all approach. Be prepared to mix
4. Remember you won’t make good decisions while you are in what you do to find something that will work for you.
an emotional setting – so avoid making key decisions when 2. Seek diversity – because experts generally look at the world
you’re stressed, angry, fearful, euphoric or greedy. Wait until through a single lens. They try to explain the world using what
you feel calmer and your tunnel vision will melt away. they know. Sometimes that’s helpful but other times it is not.
Inject loads of diversity into your decisions and they will be
5. Always understand the influence of incentives on offer – and
more robust.
consider what behaviors those incentives will motivate.
Incentives always distort decisions so be explicit about what 3. Use whatever technology is available – encode repetitive
incentives are involved. functions (like screening) into algorithms which can then be
computer based. Over time, this will enable you to become
“For various psychological reasons, humans tend to consider too more effective at making good decisions. Technology is a
few alternatives when making decisions. In many cases, the great tool to have working for you.
obvious choice is the right choice. But in a world that presents
more alternatives than it used to, tunnel vision can lead to “You could fill your shelves with books celebrating the wisdom of
substantial but entirely avoidable mistakes. You need not labor crowds, intuition, number crunching, or experts. But as a
over every decision. Rather, when the stakes are high, ask thoughtful decision maker, your prime task is to identify the
whether you are susceptible to tunnel vision. If so, scrutinize your nature of your problem and then consider how best to solve it.
decision-making process and take concrete steps to intelligently Since all approaches have their pros and cons, there is no
consider hidden possibilities.” unique solution. Technology is enabling decision makers to gain
– Michael Mauboussin invaluable insights, and some organizations are moving towards
new approaches to inform their decisions. But the biggest
obstacle is the fundamental discomfort most of us have in
Poor Decisions ý 3
þ Great Decisions handing over decisions previously made by experts to either
computers or collectives. While the evidence against experts is
in and clearly damning, human nature remains a high hurdle.”
We want to rely on Seek diversity and ensure – Michael Mauboussin
experts and like to you’re using the best
believe they know more technology which is available. “Knowing when to look beyond experts requires a totally fresh
than they really do. Remind yourself experts point of view, and one that does not come naturally. To be sure,
have a very narrow focus. the future for experts is not all bleak. Experts retain an advantage
in some crucial areas. We openly defer to people in white lab
coats or pinstripe suits, believing they hold the answers, and we
Experts most certainly have their uses. They are very good at
harbor misgivings about computer-generated outcomes. The
forecasting the outcome of hazy situations where there are a
challenge is to know when and how to use them.”
wide range of possible outcomes, but once the principles and
– Michael Mauboussin
processes involved become clear and well defined, then
 Think Twice - Page 4

3. Watch out for what Warren Buffet termed “the institutional

Poor Decisions ý 4
þ Great Decisions imperative” – the tendency for many organizations to blindly
mimic what their peers are doing. This can be seen when one
company does a merger, its competitors scramble to
We don’t always act Acknowledge decision making complete mergers of their own. This situation tends to arise
objectively but take our is an inherently social exercise whenever executives derive their financial rewards from
cues from the behaviors and therefore you need to outperforming their peers. Make decisions which are good
of those around us. manage the influences you for your own organization and not because others are doing
feel. Watch out for group think. something comparable.
4. Avoid inertia at all times and in all circumstances – make it
Sometimes, bad decisions are made because you feel social your habit to regularly revisit all your processes and analyze
pressure to go along with what everyone else on your team whether or not they are serving a vital purpose. See whether
wants to do. The people around you can influence your decisions you’ve set in stone processes which have gone beyond their
in all kinds of ways: use-by date. Chances are you’ll find plenty of processes in
n You might feel someone else is better informed than you and place which you keep using by force of habit alone.
therefore has more data on which to base their decision. “We like to think of ourselves as good decision makers: we weigh
n You might want to be part of the inner circle of influential the facts, consider the alternatives, and select the best course of
people in your group and therefore you participate actively in action. We perceive ourselves as largely immune to the
shaping the decision. influence of others as we decide and act. We convince ourselves
n You might feel external circumstances are forcing your hand that the facts and our experience carry the day, not the
to go one way or another. behavioral vagaries of those around us. Unfortunately, reality
flatly contradicts our perceptions. Decision making, whether in
n You may feel primed to go one way or another by recent
the medical office, the boardroom, or the courtroom, is an
media articles or other external events.
inherently social exercise. Primes, defaults, and the behaviors of
n Just the way the question at hand is framed and how the those around us weigh on how we decide and frequently in ways
choices are set up can influence what you end up deciding. that are beyond our consciousness. A thoughtful decision maker
n Your emotional mood and that of the people around you can recognizes these myriad influences and works to successfully
directly impact on the choices you make as well. manage them.”
As if these influences are not enough, inertia can also play a key – Michael Mauboussin
role in the decisions you make. “We’ve always done it this way” or
having in place organizational regulations which must be obeyed
come hell or high water can be the genesis of exceptionally bad
decisions.
Poor Decisions ý 5
þ Great Decisions

So how do you cope with the power of the situation and make We tend to look at Avoid focusing on just one part
better decisions? As for all the other sources of bad decisions, complex systems and of the system and instead try
the three-step approach is: seek ways to come up to gain an appreciation of the
with a simplifying overall system dynamics. If
mental model. feasible, use simulations.
Prepare Recognize Apply

Humans as a whole crave finding cause-and-effect

Or in other words, to make better decisions: relationships. This sometimes leads to problems when we take
1. Have a more keen awareness of your situation and complex systems and reduce them to simplified models we can
environment – the factors which may consciously or understand. Or we might take the performance of an individual
subconsciously influence the decision you make. Analyze and extrapolate that to come up with a forecast of how a group
your environment and control background influences. If at all will behave with disastrous consequences.
feasible, create a more positive environment which will be To illustrate, consider the question: What drives the stock price
conducive to better decision-making on your part. Keep of a company? Is it earnings per share or is it the overall cash flow
people focused on good processes, on keeping stress at an of the company?
acceptable level and so forth. Also have a willingness to
n If you believe earnings per share underpins the stock price,
devote attention to addressing the consequences of poor
then you focus intensively on what people in the investment
decisions.
community are saying. You read the Wall Street Journal
2. Always consider the situation first and the individuals religiously and seize upon each nugget of new information
involved second – which is contrary to the Western way of which might impact earnings as an indicator of the future
thinking but aligns with Eastern preferences. Westerners stock price. What people say day-to-day is important.
tend to focus more on an individual’s motives to explain their
n By contrast if you believe cash flow generates market value,
actions whereas Easterners tend to be more attuned to their
then you’ll be focused on how the market as a whole is
environments and are therefore more open to change and
behaving. If one industry’s cash flows are likely to rise in the
evolution. Whenever you’re making a new decision, start by
future due to some factor or another, then you will be
analyzing the situation first before you turn your attention to
forecasting stock prices will rise in sync. You will study the
the individuals involved.
collective market rather than worrying about what individual
companies are doing right or wrong.
 Think Twice - Page 5

ý þ
The same kind of thing plays out when companies hire superstar
CEOs or other top performers. Companies routinely pay a Poor Decisions 6 Great Decisions
premium to secure the services of top performers in anticipation
of superior results. Often, things don’t go as planned and the top We form inaccurate Acknowledge that
performers end up delivering only an average performance level. cause-and-effect circumstances can and
It turns out superstars typically have a surrounding support relationships, especially do change constantly and
system which is optimized for their talents. When they are placed for situations generated there are no universal rules
in another setting without the support system they are by circumstances. which will apply at all times.
accustomed to, their productivity reverts back to average
performance. The mistake is we isolated their individual
performance rather than seeing them as one part of a large Whether you’re conscious of it or not, what you do in business is
interrelated system. grounded in the theories you hold to be true. When you do
These mistakes arise whenever you focus on an isolated part of something different, you’re doing so in anticipation of deriving
a complex system without appreciating all of the system the benefits of a different theory. A sound theory will lead to
dynamics involved. To make better decisions when dealing with predictable and worthwhile results being delivered.
complex adaptive systems, the suggestions are: New theories generally get built in three stages:
1. Learn to look at systems at the right level – meaning if you’re
watching the performance of the market as a whole, study it Observation – we measure some kind of
at market level. When doing that, you would pay no attention 1
phenomena and document the results
to what’s happening to individual components because that
will just be background noise. Classification – we try and simplify the results
2
2. Be on the alert for tightly coupled systems – where processes and categorize things systematically
need to go from one stage to another. A commercial aircraft
is a good example of a tightly coupled system. All Definition – we start defining what the
3
components work together in a coordinated fashion. Most underlying cause-and-effect relationships are
complex or adaptive systems are much more loosely coupled
which means removing some elements will have no impact Theories then get fine-tuned and improved by testing predictions
on the larger system. In a stock market, for example, against the real-world data which gets collected. Anomalies can
removing a number of investors will have no impact at all. be highlighted and worked into the theory as things move
However, when all investors lose their diversity and start forward. Business is never as simple and clear-cut as taking a
acting in a coordinated fashion, then you start getting a single set of “keys to success” or “formula for winning” and
market boom or a bust. applying it.
3. Try developing simulations – especially if you’re dealing with A good example of this is Boeing’s experience with its
a complex system where there are no clear linkages between next-generation airliner, the 787 Dreamliner. Over the last few
cause and effect. Simulations help the learning process to decades, many people have talked about the benefits of
take root. Military planners and pilots use simulations outsourcing to drive down costs within a supply chain. To gain
extensively and more companies should pick up on this these benefits, Boeing decided to move from doing everything
learning and planning tool. in-house to using suppliers who would build complete airplane
“Even though complex adaptive systems surround us more now, sections according to the detailed blueprints Boeing provided.
our minds are no more adept at understanding them. Our innate Boeing hoped in this way, what was traditionally a capital
desire to cause and effect leads us to understand the system at intensive and labor intensive final assembly process of thirty
the wrong level, resulting in predictable mistakes. Unintended days could be pared back to three days.
consequences can lead to failure when well-meaning individuals Unfortunately, what sounded reasonable in theory ended up
attempt to manage the system to achieve a particular goal. So if being a disaster in practice. Despite the fact suppliers had
you deal with a complex adaptive system, make sure you detailed blueprints and specifications, Boeing found suppliers
carefully set your system-level goal and proceed with caution in interpreted those blueprints in subtly different ways. The end
implementing agent-level changes for achieving your objective.” result was components made by different suppliers would not
– Michael Mauboussin match up to other modules as planned. Boeing ended up having
to bring much design work back in house in order to get
“Thinking twice is really a story of opportunity. The opportunity everything to integrate properly. The 787 is two years behind
comes in two flavors. You can reduce the number of mistakes schedule and many billions over budget as a result of Boeing
you make by thinking about problems more clearly. Also, you can embracing a management theory that sounds good but does not
see and capitalize on the mistakes other people make. As work for complex products like a commercial airliner.
shrewd businesspeople know, one man’s mistakes is another’s
opportunity. Over time, the most rational thinker will win. “Outsourcing does make sense for industries where
Thinking twice is about identifying those opportunities.” subcomponents are modules. In these cases, the performance
– Michael Mauboussin of the subcomponents is well defined, and the final assembly is
straightforward. Today, you can build a personal computer
“Intelligent people perform better only when you tell them what to yourself with standardized modules. Once an industry defines
do.” the modules, then it makes more sense for suppliers to
– Keith Stanovich, psychologist, University of Toronto specialize in one component instead of trying to make them all.
Assemblers like Dell can then focus on design, marketing and
 Think Twice - Page 6

distribution. Before the 787, Boeing had controlled the design

and engineering processes for its planes, ensuring the
compatibility of the components and a smooth final assembly.
Poor Decisions ý 7
þ Great Decisions

Buy by ceding design and engineering to suppliers, Boeing’s 787

program became a case study in when to avoid outsourcing. We’re not really all that Be aware of the power
Boeing was drawn to outsourcing as an attribute, without fully familiar with tipping and reach of coordinated
recognizing the circumstances under which it would work.” points where a small behavior and be careful
– Michael Mauboussin change can lead to not to extrapolate the
major consequences. past into the future.
Not only do business theories have to be well put together and
applied in their right context to have any value but you’ve also got
to be careful to be aware of all kinds of strange correlations which When you freeze water, it stays a liquid until suddenly at freezing
pop up all over the place. A simple example in stock markets is point, it becomes ice. You can cool it by 5 degrees or more above
the “Super Bowl Indicator” which states: “When the National freezing point and nothing much happens – the water just gets a
Football Conference team wins the Super Bowl, the stock market little chillier. But at freezing point, just a one degree change in
will go up. When the American Football Conference team wins, temperature is enough for a major transition to occur. This same
the stock market will go down.” The Super Bowl Indicator has phenomena crops up in all kinds of complex systems. There is a
correctly forecast the stock market’s direction 80 percent of the trigger point where a small change in one factor causes a major
time from 1967 to 2008. In other words, there is a clear statistical phase transition.
correlation but there is no causal relationship. Obviously what The financial crisis of 2007-2009 was a good example of this
happens on a sports field can’t and won’t have any material phenomena in action. The genesis of the market meltdown was
impact on what the stock market as a whole does. When you’re the fact a statistician (named David Li) had come up with a
dealing with business theories, you’ve got to make sure you’re formula which purported to measure the likelihood of default
actually looking at quantifiable causes rather than quirks of between different types of financial assets. This formula could
statistical correlation. then be used to calculate how much financial risk you were
To ensure you’re correctly considering circumstances exposed to when investing in assets which were a collection of
systematically when you make business decisions: financial investments. Thus, the financial derivatives market was
born and companies started investing in bundles of investments
1. Look at whether the theory you’re using correctly allows for which they believed were sufficiently diversified.
circumstances – or are you merely extrapolating successful
choices from the past into new situations? This is what It turned out the formula had a fatal flaw. It was accurate when
happens when consultants study successful organizations financial assets acted independently, but underlying correlations
and come up with a universal set of “business laws” which could still exist in a complex and dynamic world. Instead of acting
guarantee success. They don’t exist. Business is too independently, all financial assets started acting in sync which
complex and the context is too varied for one single set of meant diversification went out the window. It turned out everyone
principles to guarantee success in every industry and in had taken on more risk than they imagined and this set off a chain
every market around the world. reaction that led to one default after another. Just a small change
in the condition of the stock markets ended up generating a
2. Watch for correlation oddities – where people are trying to substantial and largely unpredicted loss of value across the
see cause-and-effect relationships which don’t exist. We all entire marketplace.
have a tendency to reach conclusions which are a stretch of
the facts so be on guard. So what can you do to avoid falling foul of these kinds of phase
transitions? As usual, there are no absolute guarantees but
3. Balance your desire for simple rules with an awareness of the ideas worth pursuing would include:
impact of changing conditions – which in effect means to be
skeptical of anything which is “universal”. In evolution theory, 1. Study the distribution of outcomes you’re dealing with – and
the strongest doesn’t always survive. It’s whichever species don’t explain away any extreme events as anomalies. Figure
adapts to changing circumstances the fastest. So too in out how you can prepare for everything the system can
business. Being big is no guarantee of success but it’s the generate, extreme event or not. Be aware you might not have
entities which adapt the best to changing marketplace cause-and-effect figured out nearly as thoroughly as you
conditions which do well. think you do and prepare accordingly.
4. Always be wary of “best practices” as well – because what 2. Look for major phase transitions – where just a small change
works just fine in one realm may be entirely wrong for a can generate extreme reactions. When people start acting in
different market niche. All players have strengths and a coordinated fashion rather than in a random fashion,
weaknesses and it’s what you to take advantage of your own incredible power can be generated. The dot-com boom of the
strengths that matters, not how good anyone else is. late 1990s and the financial market meltdown of 2007-2009
are worthwhile illustrations of this phenomena in action.
“Most of us look forward to leveraging our favorable experiences Don’t always assume randomness will reign supreme.
by applying the same approach to the next situation. We also 3. Beware of forecasters – who will tell you they know what’s
have a thirst for success formulas – key steps to enriching going on to a number of decimal points accuracy. Be
ourselves. Sometimes our experience and nostrums work, but especially wary of anyone who makes a forecast which spans
more often they fail us. The reason usually boils down to the multiple domains. Any one of them can have arbitrary
simple reality that the theories guiding our decisions are based problems in hiding which the forecasters are not aware of.
on attributes, not circumstances.” Prepare for all contingencies at all times and in all
– Michael Mauboussin circumstances.
 Think Twice - Page 7

4. Do what you can to mitigate the downside while at the same enjoy great leadership, a visionary strategy or superior financial
time still harnessing the upside – which essentially means controls. We then recommend others embrace those same
you should never bet more than you can afford to lose on any attributes to also become successful. The halo effect completely
particular outcome. The ideal is to get cost-effective ignores the role of luck. If stellar performance subsequently
exposure to positive events at the same time as you insure reverts back to average performance, observers then conclude
against the arrival of major negative events. those features went wrong whereas in reality nothing has
changed. The people are doing all the same things but a run of
“Consequences are more important than probabilities.” good luck has ended as it always does.
– Peter Bernstein, investor
This halo effect is prominent in the business press. Frequently,
“Increasingly, people must deal with systems that are marked by companies which are featured in glowing terms as cover stories
abrupt, unforeseeable change and rare but possible outcomes. in Business Week, Forbes and Fortune magazines then end up
We are all particularly mistake-prone with these systems turning in an abysmal performance over the next two or so years.
because we intuitively want to treat the system as being simpler Their run of success which attracted the attention of the
than it is and to extrapolate the past into the future. Flag those magazine’s editors ultimately reverts to the mean. Professional
systems w hen you see them, and slow down your sports teams observe this same phenomena – appropriately
decision-making procedures.” termed the “Sports Illustrated Jinx” – where teams or athletes
– Michael Mauboussin which appear on the magazine’s cover will immediately go into a
prolonged slump.

Poor Decisions ý 8
þ Great Decisions
So how do you avoid these reversion to the mean style mistakes
when making decisions? Some suggestions:
1. Become more realistic about evaluating the amount of luck
We overemphasize the Evaluate the mix of skill and involved in the system you are analyzing – which is rarely
effect our skill has on the luck in the system you’re easy to do. When something good happens, it’s human
result and minimize the looking at and be careful about nature to assume that was because of skill. Similarly,
impact of luck in our any conclusions you draw whenever something bad happens, you’re more likely to
successes. which rely on luck. consider it to be the result of bad luck. Be realistic and careful
about drawing conclusions around anything which involves
How much of your past successes have been due to good luck luck.
and how much has been the result of skill? Humans have a very 2. Consider the sample size you’re looking at – and see whether
difficult time differentiating between the two. As a result, we fail to enlarging your data sample will allow you to draw more robust
acknowledge over the long run, results always revert to the conclusions. The more data you’re using in your sample, the
mean. Because of this, you can make three kinds of mistakes: better you understand everything involved and can draw the
n You think the person you’re dealing with is “special” – and correct conclusions.
therefore not bound by the law of averages. This is what 3. Watch out for changes in the system – because not all
happens when corporate leaders think they’ve figured out a systems remain stable over an extended period. Whenever a
better way to run their businesses and therefore they will system changes, the mix of skill and luck changes as well.
always turn in above average performance. Don’t fall for it. Keep this in mind as you analyze the data.
Luck has more impact than they’re admitting to themselves. 4. Always remain on the lookout for the halo effect – where
This is why investors pour money into funds run by managers someone wants to offer you a tidy solution to your problems
which have beaten the market over the past couple of years based on emulating what’s worked for someone else.
only to pull it out when that fund’s lucky streak ends and its Business is much too complex for simple solutions which are
performance reverts back to average. These people are guaranteed to work under any conditions and circumstances
buying high and selling low because they ignore reversion. to exist. Anyone who offers you a proven formula, a set of
n You can easily misinterpret the data – and look for cases of rules to live by or a set of attributes you need to have is trying
sustained outstanding performance when in reality what to sell you the Brooklyn Bridge. They’re trying to sell
you’re actually seeing would be a reversion towards the something they don’t even have themselves. Be very wary.
long-term average. Put another way, all markets tend towards
“Here’s a simple test of whether an activity involves skill: ask if
mediocrity. Competitive advantage is never absolute and
you can lose it on purpose. Think about casino games like
inexhaustible. Eventually, everyone reverts to the mean.
roulette or slots. Winning or losing is purely a matter of luck. It
Extreme results, based on either really good luck or really bad
doesn’t matter what you do. But if you can lose on purpose, then
luck, will be followed by other periods which will be less
skill is involved. This simple test reveals the role of luck in
extreme and which will even things out.
investing. When most people recognize that it is hard to
n You can get confused about what kind of feedback is most construct a portfolio that beats the S&P 500, most people don’t
productive – and base your actions on that part of the know how hard it is to build a portfolio that will do a lot worse than
outcome the person can’t control (the luck) rather than that the benchmark.”
part they can control (their skill). Giving your people feedback – Michael Mauboussin
based only on outcomes is of no practical value whatsoever if
you fail to differentiate between skill and luck. “When outcomes are really good because of a dose of good luck,
The existence of a “halo effect” is well documented in business. prepare for the times when they will be closer to the average.
In practical terms, this means we observe successful When outcomes are disappointing as the result of bad luck,
organizations and attach attributes to their success – like they recognize things will get better.”
– Michael Mauboussin
 Think Twice - Page 8

6 Try performing a decision “premortem” – the opposite of a

Poor Decisions ý þ Great Decisions
postmortem. Assume you are looking back from the future at
a decision which has failed. Try to anticipate what the cause
of failure was and do something to address it sooner rather
than later. Track your premortems in your decision journal so
How to improve your decision making immediately you can become more attuned to picking up on early signs of
trouble.
7 Acknowledge there are things you cannot know in advance –
1 Raise your awareness level – identify the mistakes you
especially when you’re dealing with a complex system with a
commonly make in your normal business processes and
large number of interacting components. Cause-and-effect
resolve to do something about them. Recognize when you’re
linkages are often obscured and it’s difficult to know what will
using sloppy thinking and start thinking clearly about the
be the result of varying one component or another.
problems you face. Remember, there’s always a hindsight
Acknowledge those complexities and feel good about stating
bias where we tend to think the solution was obvious after the
you simply don’t know how things will play out.
fact, but it seldom is at the time. Be more aware.
2 Use empathy – put yourself in the position of other people “There’s a funny paradox with decision making. Almost everyone
who faced similar challenges and study how they responded. realizes how important it is, yet few people practice. Why don’t
If you learn from the mistakes of others rather than repeating we drill young students on decision making? How come so few
them over, that’s good. If others have to live with the professionals – executives, doctors, lawyers, and government
consequences of what you decide, get to understand their officials – are versed in these big ideas?”
perspective and point of view. You might still end up making – Michael Mauboussin
the same decision but you’ll do so with your eyes open.
“Three factors determine the outcomes of your decisions: how
3 Never forget to acknowledge the role of luck – or at the very you think about the problem, your actions, and luck. You can
least the impact of a little skill combined with luck. Sorting out familiarize yourself with common mistakes, recognize the
skill from luck is a key step in making better decisions. If luck situation you’re in, and take what appears to be the correct
determines the outcome, you know ultimately outcomes will action. But luck, by definition, is beyond your control, even
revert to the average. Outstanding one-off outcomes are though it may determine the outcome (especially over the short
going to be followed by a succession of average outcomes in term). That statistical reality begs a fundamental question:
the future. Also, if you’re evaluating the performance of should you evaluate the quality of your decisions based on the
another person, make sure you differentiate between what process by which you make the decision or by its outcome? The
was generated by their skill and what was generated by luck. intuitive answer is to focus on outcomes. Outcomes are
Don’t confuse luck for skill, especially if you are providing objective and sort winners from losers. In many cases, those
criticism of their performance. evaluating a decision believe that a favorable outcome is
4 Solicit as much feedback as possible – because feedback evidence of a good process. While pervasive, this mode of
which is timely and clear will over time help you improve your thinking is a really bad habit. Kicking the habit opens up a world
decision making skills. Try keeping a journal cataloging the of insight into decision making. Our most challenging decisions
decisions you make and the reasoning you used. Once an include an element of uncertainty, and at best we can express
outcome emerges, you can then go back and audit your the possible outcomes as probabilities. In a probabilistic
decision making process. You can look for clues as to how a environment, you are better served by focusing on the process
poor decision was reached. A journal will also enable you to by which you make a decision than on the outcome. When
look for patterns and relationships. You may find you make evaluating other people’s decisions, you are better served by
better decisions when you’re in a reflective mood than you do looking at their decision-making process rather than on the
when in a more agitated state. If that’s the case, you can then outcome. There are plenty of people who succeed largely by
develop a game plan for each day based on the mood you’re chance. More often than not, they are completely unaware of
in. Keeping a decision journal is a structured tool for all kinds how they did it. But they almost always get their comeuppance
of analysis and introspection. when fortune stops smiling on them. Likewise, skillful people
5 Develop a decision checklist – the items you should work who have suffered a period of poor outcomes are often a good
through when making a decision. Pilots use checklists before bet, since luck evens out over time.”
take-off and before landing to ensure they can operate – Michael Mauboussin
safely. Admittedly, checklists are less useful in rapidly “Smart people make poor decisions because they have the
changing environments but in many business domains, that same factory settings on their mental software as the rest of us,
is simply not the case. You have to find a balance between a and the software isn’t designed to deal with many of today’s
checklist which is so general it is too vague and one which is problems. So our minds frequently want to see the world one
specific enough to guide action. Try creating a one- or way – the default – while a better way to see the world takes
two-page checklist you run through each time you have to some mental effort. Beyond the problem of mental software,
make a decision and see how it goes. Find out what other smart people also make bad decisions because they harbor
kinds of issues surface in practice. Analyze whether past false beliefs. These beliefs prevent clear thinking. To make good
poor decisions have been a case of neglecting a step rather decisions, you frequently must think twice – and that’s something
than executing other steps poorly. our minds would rather not do.”
– Michael Mauboussin

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