Finding Financial Wisdom In Unconventional Places MICHAEL J. MAUBOUSSIN MORE THAN YOU KNOW Finding Financial Wisdom in Unconventional Places MORE THAN YOU KNOW 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 20 1 2 3 4 5 6 7 8 9 30 1 2 3 4 5 6 MORE THAN YOU KNOW Finding Financial Wisdom in Unconventional Places Columbia University Press New York 610-037-cmp2-001-r01.indd 2 3/14/06 11:10:41 AM MORE THAN YOU KNOW Finding Financial Wisdom in Unconventional Places Michael J. Mauboussin 610-037-cmp2-001-r01.indd 3 3/14/06 11:10:46 AM Columbia University Press Publishers Since 1893 New York Chichester, West Sussex Copyright © 2006 Michael J. Mauboussin All rights reserved Library of Congress Cataloging-in-Publication Data Mauboussin, Michael J., 1964– More than you know : fi nding fi nancial wisdom in unconventional places / Michael J. Mauboussin. p. cm. Includes bibliographical references and index. ISBN 0–231–13870–9 (cloth : alk. paper) 1. Investments. 2. Investments—Psychological aspects. 3. Finance, Personal. I. Title. HG4521 .M365 2006 332.6—dc22 2005034238 A Columbia University Press books are printed on permanent and durable acid-free paper. Printed in the United States of America c 10 9 8 7 6 5 4 3 2 1 A balanced perspective cannot be acquired by studying disci- plines in pieces but through pursuit of the consilience among them. Such unifi cation will come hard. But I think it is inevi- table. Intellectually it rings true, and it gratifi es impulses that rise from the admirable side of human nature. To the extent that the gaps between the great branches of learning can be narrowed, diversity and depth of knowledge will increase. —Edward O. Wilson, Consilience To my parents Who always stood behind me but were never too close contents Acknowledgments xvii Introduction 1 PART 1: Investment Philosophy Introduction 7 1 Be the House: Process and Outcome in Investing 9 Hit Me 9 From Treasury to Treasure 11 Prioritizing Process 14 2 Investing—Profession or Business? Thoughts on Beating the Market Index 15 The Scouting Report 15 Evaluating the Winners 17 The Investing Profession Versus the Investment Business 19 3 The Babe Ruth Effect: Frequency Versus Magnitude in Expected Value 23 Batting with the Babe 23 The Downside of Hardwiring 24 Bulls, Bears, and Odds 25 From OTC to OTB 26 A Useful Analogy 27 4 Sound Theory for the Attribute Weary: The Importance of Circumstance-Based Categorization 29 Circumstance Over Attributes 29 The Three Steps of Theory Building 30 When, Not What 33 [...]... profitable More Than You Know s core premise is simple to explain but devilishly difficult to live: you will be a better investor, executive, parent, friend— person—if you approach problems from a multidisciplinary perspective It’s the difference between moving into a fixer-upper home with a full set of power tools versus a simple screwdriver You are going to be a lot more successful and efficient if you have... More Than You Know leverages the research of many top-flight academics But given the book’s format, there is no way to give those academic ideas their full due That’s why I assembled a detailed reference section, including suggestions for further reading Hopefully, the references will give you plenty to dig in to should you chose to follow up on an idea or theme My sincerest wish is that More Than You. .. idea as well Consilience literally means the “jumping together” of knowledge Wilson argues that we can unify knowledge across diverse disciplines—physics, biology, economics, and the arts, for instance—at a fundamental level Indeed, you have to think across disciplines to deepen your understanding of how things work So More Than You Know celebrates learning about the world with an eye toward building... it captures much of SFI’s spirit Finally, a word on how to read this book Unlike a best-selling thriller, you can read More Than You Know from back to front just as easily as from 3 4 INTRODUCTION front to back But I recommend you simply go to the table of contents, find something that interests you, and jump in While the essays cover a range of topics, I categorize them into four parts—investment philosophy,... better overall results, and more thoughtful decisionmaking can be encouraged by evaluating decisions on how well they were made rather than on outcome —Robert Rubin, Harvard Commencement Address, 2001 Any time you make a bet with the best of it, where the odds are in your favor, you have earned something on that bet, whether you actually win or lose the bet By the same token, when you make a bet with the... and counsel My mother-in-law, Andrea Maloney Schara, is the rare grandmother who can explain systems theory and throw a football Finally, I thank my children Andrew, Alex, Madeline, Isabelle, and Patrick for allowing me to see diversity firsthand MORE THAN YOU KNOW i n t ro d u c t i o n I remember the exact moment the idea for The Consilient Observer hatched It was the summer of 2000, and my wife’s... Norman Johnson, Jim Surowiecki, and Duncan Watts Thanks to each of you for sharing your ideas with me so generously Steve Waite’s suggestions were also of great benefit to me I’d like to thank Myles Thompson, my publisher and editor at Columbia University Press, for his boundless enthusiasm and unwavering belief in the power of these ideas Assistant editor Ann Young has also been an immense help in all aspects... Hazardous to Your Wealth 180 Beyond Newton Sorting Systems The Stock Market as a Complex Adaptive System Using What You ve Got 180 181 183 184 28 Chasing Laplace’s Demon: The Role of Cause and Effect in Markets Evolution Made Me Do It Laplace’s Demon 185 185 187 CONTENTS Interpreting the Market Investor Risks 29 More Power to You: Power Laws and What They Mean for Investors Zipf It The More Things Change... gambling you re better off focusing on the decision-making process than on the short-term outcome This emphasis is much easier announced than achieved because outcomes are objective while processes are more subjective But a quality process, which often includes a large dose of theory, is the surest path to long-term success That leads to the second theme, the importance of taking a long-term perspective You. .. a framework that helps you understand the problem you face He argues for constructing a latticework of models so you can effectively solve as many problems as possible The idea is to fit a model to the problem and not, in his words, to “torture reality” to fit your model Certain character traits encourage the mental-models method to blossom Fortunately, these are mostly traits you can choose: intellectual . 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 20 1 2 3 4 5 6 7 8 9 30 1 2 3 4 5 6 MORE THAN YOU KNOW Finding Financial Wisdom in Unconventional Places Columbia University Press New York 61 0-0 37-cmp 2-0 01-r01.indd 2 3/14/06 11:10:41 AM MORE THAN YOU KNOW Finding. Finding Financial Wisdom In Unconventional Places MICHAEL J. MAUBOUSSIN MORE THAN YOU KNOW Finding Financial Wisdom in Unconventional Places MORE THAN YOU KNOW 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 20 1 2 3 4 5 6 7 8 9 30 1 2 3 4 5 6 MORE. Copyright © 2006 Michael J. Mauboussin All rights reserved Library of Congress Cataloging-in-Publication Data Mauboussin, Michael J. , 1964– More than you know : fi nding fi nancial wisdom in unconventional