Investment tips: Think twice before making the trade

Investors should perform a pre-mortem on their investment choices, before putting a trade into action. That way, they may find themselves spotting 30 percent more alternatives – avoiding what could prove to be a disastrous investment decision. That is the message from best-selling author Michael Mauboussin, who is also chief investment strategist at US group Legg Mason Capital Management. He was speaking at the annual African Cup of Investment Management conference in early September of which Sanlam Investment Management is lead sponsor.

According to Mauboussin, investors should position themselves in the future looking back at the potential outcome of their decision before investing. “Before you make your decision, for example going long or short gold, pretend it is September 2012 and the trade turned out poorly. Write down why the trade didn’t work.” He says this ‘pre-mortem’ gives investors much better perspective than when standing in the present, looking into the future.

Mauboussin offered further tips for improving decision-making in the investment world. He said investors should maintain an investment journal, and create a checklist before investing. “Write down what you decided, why you decided it and how you felt when you made the decision. When you can see it written down, it gives you true feedback about your decisions.”

Mauboussin is the author of the book, Think Twice: Harnessing the Power of Counterintuition. He said that some of the greatest blunders have been made by some of the smartest people. “The message is that we all come with the same software, and when faced with situations, our minds all go down one path. But we should be thinking twice.”

Humans, he said, make three key mistakes. They choose their own intuition and assessments above the experience of others who have been in the same situation before them. Mauboussin said, “It’s well known that mergers and acquisitions destroy value 60 percent of the time. But every CEO believes his deal is going to be the successful one.”

Humans also tend to anchor values. He said, “As much as you’d like to believe you are rational and objective, what is going on around you deeply influences what you decide.” As an example, research has shown that the valuations made by real estate brokers who participated in the survey were heavily influenced by the listing prices, as opposed to their own independent judgment. So the higher the listing price, the higher their valuation tended to be.

Mauboussin also advised individuals to be wary of the experts and their predictions. “Experts’ forecasts in politics, social and economics are known to be horribly inaccurate, yet we continue to pay attention to these. You need to recognise when experts do well and when they don’t do well.” He said studies have found that averages from crowds often enjoy better results when making predictions than the experts, although there are also times when crowds get it horribly wrong.

He warned investment managers to be wary of making decisions based on intuition. Intuition worked when a system was stable and linear, he said. “If it is not stable and linear, then all bets are off. And are markets stable and linear?”

At the essence of Mauboussin’s thesis is that investors should think twice before making decisions: instead of acting on your initial decision, step back and prepare your mind by building a mental database of similar situations you’ve encountered before and then make the decision based on this context.