Finding Financial Wisdom in Unconventional Places

289 Pages·2006·23.92 MB·English

MORE THAN YOU KNOW
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Finding Financial Wisdom in Unconventional Places
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MORE THAN YOU KNOW
Finding Financial Wisdom in Unconventional Places
Michael J. Mauboussin
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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
x CONTENTS
5 Risky Business: Risk, Uncertainty, and Prediction in Investing 35
Rocket Science 35
From Uncertainty to Probability 36
How Predictions Change Future Payoffs 39
6 The Hot Hand in Investing:
What Streaks Tell Us About Perception, Probability, and Skill 40
Finding the Hot Shot 40
Streaks and Skill 41
Toss Out the Coin Toss 42
Streaks and Luck 44
7 Time Is on My Side: Myopic Loss Aversion and Portfolio Turnover 46
One or One Hundred 46
Explaining the Equity-Risk Premium 47
The Value of Inactivity 49
Pictures Worth a Thousand Words 53
PART 2: Psychology of Investing
Introduction 57
8 Good Morning, Let the Stress Begin:
Linking Stress to Suboptimal Portfolio Management 59
Why Zebras Don’t Get Ulcers 59
Why Money Managers Do Get Ulcers 60
Shortening Horizons 61
Imitating Ulysses 64
9 All I Really Need to Know I Learned at a Tupperware Party:
What Tupperware Parties Teach You About Investing and Life 65
A Tip from Shining Shoes 65
You Can Fool Mother Nature 66