Tom Brakke is a terrific analyst. His new piece (“analogies and anomalies“) is excellent as usual and provides a helpful complement to my similarly focused piece from yesterday (featured here too). As Tom points out, “Differential information is critical and early warnings are highly prized, yet as an industry we waste a lot of time borrowing and reinforcing conceptual structures that are already formed rather than trying to shoot holes in them. And most strive too hard to find analogies when anomalies are staring them in the face and going unrecognized or unexamined.” I also encourage you to read Stories vs. anomalies by Tadas Viskanta of Abnormal Returns, which compares and contrasts Tom’s piece and mine.
It is one thing to recognize our inherent biases and cognitive difficulties, of course (why we too readily buy analogies and too routinely dismiss anomalies), and quite another actually to do something about them. I suggest that you start by using what Harvard Medical School’s Atul Gawande calls “the power of negative thinking.” That means (consistent with Tom’s advice) actively looking for failures and how to overcome them. Consider everything that can go wrong and plan as if each is a very real possibility. We need to have good contingency plans because we are going to miss important things far too often.
Write things down. By writing things down we can help to minimize hindsight bias. Practically speaking, having written plans with our clients and well-documented reasons for our clients’ decisions will limit the threat to our client relationships because of clients’ hindsight bias (and our own).
Check your work. One of the best cures for overconfidence is feedback. If you think you’re a marksman, go the range and test your hypothesis. In your business, have an accountability partner you respect to make sure you’re doing as well as you think you are (because of confirmation bias, we tend to reject feedback that we don’t like) and carefully examine if your clients’ portfolios are doing what they were intended to do (which of course correlates to the need for written goals and objectives). As Nobel laureate Dan Kahneman emphasizes in his brilliant Thinking Fast and Slow, outsiders can always see such things more readily and more clearly than insiders (we) can. It always pays to check your work and to have it checked by someone you trust.
A good dose of humility, along with an acknowledgement of the old axiom that the markets can stay irrational longer than investors remain solvent is always sound advice. Astute asset allocation, portfolio rebalancing and careful attention to investors’ risk tolerances and their ability to withstand losses and other difficulties always makes sense. And we all need contingency plans.
We’re going to make mistakes. Our clients are too. That’s a given. How we handle those mistakes is vital. But how we prepare for these inevitable mistakes is perhaps more important still.
Above the Market 
Pingback: On Data and Certainty | Above the Market