This book uses entertaining illustrations to make important points about decision making, including the following: (1) Expert opinions are helpful in certain situations but much less so in others, and (2) sensory responses can influence choices in illogical ways. The author challenges established beliefs and offers practical steps for avoiding the traps that counterintuitive effects create. Readers will sharpen their thinking if they take up the challenges presented by games and puzzles scattered throughout the text. If they also absorb the larger lessons that these exercises teach, investors may avoid many costly errors that arise from recognizable errors of logic.
This regression model of the quality of red Bordeaux wines, devised by economist Orley Ashenfelter, enables a computer to deliver appraisals more quickly and more reliably than experts in the field. Think Twice: Harnessing the Power of Counterintuition further punctures the oenophile’s mystique by reporting an experiment in which shoppers were presented with a display of a French wine and another of a German wine of equivalent price and quality. When the store played recordings of French accordion music, 77 percent of shoppers chose the French wine, whereas 73 percent selected the German wine when German Bierkeller music was played. When asked to explain their choices, the shoppers denied the statistically incontrovertible fact that the music had influenced them and instead cited the wine’s characteristics and the meal with which they planned to serve it.
Michael Mauboussin uses these entertaining illustrations to make two important points about decision making: (1) Expert opinions are helpful in certain situations but much less so in others, and (2) sensory responses can influence choices in illogical ways. Chapter by chapter, Mauboussin offers practical steps for avoiding the traps that these counterintuitive effects create.
In addition to serving as chief investment strategist at Legg Mason Capital Management, Mauboussin is an adjunct professor of finance at Columbia Business School. Readers of Think Twice will benefit from his assiduous collecting of interesting lecture material. Sports enthusiasts may be surprised to learn that “combine” rankings (scores on physical tests given to prospects for the annual talent draft) have no consistent relationship with subsequent performance in the National Football League.1 Those who wrestle with political questions of choice and freedom may puzzle over the fact that almost 100 percent of Austrians have agreed to be organ donors but only about 12 percent of Germans have done so. The difference is that Germans must opt in, whereas Austrians are asked whether they do not want to become organ donors.
Mauboussin was so energetic in assembling material that his bibliography lists 327 items in support of 143 pages of narrative. To be sure, certain of his anecdotes and concepts may have a familiar ring. He draws from such recent, widely read books as Nassim Taleb’s The Black Swan , Malcolm Gladwell’s The Tipping Point , and Michael Lewis’s Moneyball .
One topic on which Mauboussin presents original research, however, is corporate performance. He shows that, over time, companies that achieve below-average or above-average spreads between return on invested capital and weighted average cost of capital revert toward the mean. Mauboussin also cites research showing that the stocks of companies lauded by major business magazines subsequently underperform the stocks of companies excoriated by the same periodicals. The business magazines invariably attribute the successful companies’ high profitability to distinctive organizational and strategic characteristics that somehow fade over time.
Carrying the point further, Mauboussin debunks the best-seller Good to Great: Why Some Companies Make the Leap . . . and Others Don’t , in which author Jim Collins asserts that the 11 great companies he profiles are all “hedgehogs” that focus passionately on what they do best. Mauboussin comments:
The important question is not, “were all great companies hedgehogs?” but “were all hedgehogs great?” If the answer to the latter question is no—and it assuredly is—then dwelling on the survivors creates a bias in the analysis, leading to faulty conclusions.
These are gratifying words for readers who have wondered about the real value of trendy management tomes. Many “great” companies have stumbled after being showcased in such books, which suggests that their periods of excellence reflected transitory conditions in the competitive environment rather than unusually effective corporate cultures.
Each chapter of Think Twice challenges established beliefs. Contrary to the tenets of behavioral finance, says Mauboussin, the demonstrable irrationality of the individual does not ensure that the market will be irrational. In a complex system like the stock market, collective behavior matters more than individual behavior. Summarizing research that disputed earlier findings, Mauboussin reports that “studies consistently show that birth order has little or no effect on personality.” Finally, work published by Benoit Mandelbrot 45 years ago, which has been neither refuted nor widely accepted, shows that asset prices are far more volatile than standard statistical models assume.
Readers of Think Twice should not expect to acquire investment tools per se. They will, however, sharpen their thinking if they take up the challenges presented by games and puzzles that the author scatters throughout the text. If they also absorb the larger lessons that these exercises teach, investors may avoid many costly errors that arise from recognizable errors of logic.
—M.S.F.