This is the third article in a series that shines a light on Michael Mauboussin’s ten attributes of successful investors.
Michael Mauboussin is the director of research for BlueMountain Capital Management and used to be the MD and Head of Global Financial Strategies at Credit Suisse.
5. Think in terms of probabilities
There are no absolutes in investing, and you should always think in terms of probabilities.
As investing deals with events in the future, there is a myriad of possibilities as to what can happen.
As investors, we need to assign probabilities to scenarios which we feel have a realistic chance of occurrence.
There are several ways to come up with probabilities.
One method is known as “subjective probabilities” which ties in with a state of knowledge or a belief system.
The problem is that markets and businesses constantly change and evolve, making it tough to assign accurate probabilities.
If new information shows up, an investor may fail to account for it and thus end up assigning an erroneous probability.
A more useful method is the “frequency” approach, which considers the outcomes of attributes such as profit and sales growth rates.
The investor can compare these against similar companies to gain a sense of where the probabilities lie.
The idea here is that outcomes may not always reflect the quality of the original decision.
In investing, it’s important to focus on following the right process rather than rely on the investment outcome to determine the correctness of the original decision.
6. Update your views effectively
The need to update your views ties in with confirmation bias, an emotional bias that you need to guard against when investing.
Confirmation bias describes a situation where investors actively seek out information which conforms to their beliefs while rejecting information which goes against what they perceive to be correct.
Mauboussin states that “beliefs are hypotheses to be tested, not treasures to be protected”.
It’s sage advice that instructs us to continually question and challenge our own beliefs.
Nothing is so sacred that it cannot be proven wrong, as long as it is backed by objective evidence.
Successful investors need to do two things.
The first is to actively seek out information or opinions which are different from their own.
And when found, they need to incorporate these into their investment process.
Neither is easy to do, but if successful, it would greatly improve your investment performance over time.
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Disclaimer: Royston Yang does not own any of the companies mentioned.