Swedroe: The Power Of Counterintuition

February 21, 2019

Chapter 6: We try to apply general rules in contexts that are not appropriate. As Mauboussin says, “it depends.” Importantly, correlation doesn’t imply causation. We must ask: Does the theory behind your decision account for circumstances?

Chapter 7: Small changes in a system can lead to a large change in output. We mess things up by assuming the same input will always have the same output. When making decisions, it’s critical to understand that the consequences of our actions are far more important than what we think are the estimated probabilities of outcomes. Thus, we should consider the potential dispersion of outcomes and be prepared to deal with any outcome, developing strategies to minimize the risks of the downside. We also need to beware of forecasters who tend to be highly confident of their predictions.

Chapter 8: Any system that combines skill and luck will revert to the mean over time. Ignoring this “law” makes people think they are special and that the rules of probability don't apply to them. This is reinforced by the “halo effect”—when someone is doing well, the media tends to lionize every trait of that individual. Of course, when they revert to the mean, the media tends to ignore the poor performance and forget all the praise they had heaped on the person.

Key Conclusions

Mauboussin concludes the book with some recommendations, including to remember to think twice before we make a serious decision. Other recommendations include:

  • Seek diversity of opinion from diverse sources of information and dissenting views.
  • Learn from the experiences of others in similar situations (making use of statistics when possible) rather than relying only on your own perspective.
  • Don't be excessively optimistic about expecting to beat the odds.
  • Beware of anecdotal information, and don’t infer patterns where they don’t exist. Make appropriate use of the power of information technology.
  • Don’t assume correlation indicates causation. Have an intuitive theory to support the evidence.
  • Avoid bias of favoring evidence that supports your beliefs, while ignoring contradictory evidence.
  • Avoid making decisions when in emotional distress (stress, anger, fear, anxiety, greed, euphoria, grief, and so on).
  • Beware of how incentives, situational pressures and the way choices are presented may consciously or subconsciously impact behavior and shape decisions.
  • Consider the full range of possible outcomes and employ strategies that mitigate downside risks while capturing upside potential.
  • Understand that luck often plays a role in success or failure. It’s important to consider the quality of the decision-making process and to not overestimate the role of skill (or lack thereof). A useful test of how much difference skill makes in a particular situation is to ask how easy it is to lose on purpose.
  • Make use of checklists to help ensure that important things aren’t forgotten.
  • Know what it is you cannot know, understanding that most surprises are unpleasant.
  • Perform a “premortem” examination, assuming that your decision hasn't worked out. Come up with plausible explanations for the failure and revise the decision to improve the likelihood of a better outcome.

As Maboussin notes: "No one wakes up thinking, ‘I am going to make bad decisions today.’ Yet we all make them.” In a clear style, Mauboussin informs us about our mistakes and how to avoid them. He engages the reader with interesting stories and experiments that bring the message to life. The book makes a valuable contribution to the literature on decision making when both luck and skill are involved. It is thoroughly researched and well written. I highly recommend the book to anyone interested in making better decisions (including better investment choices).

 

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.

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