How Advisors Can Make Better Investing Decisions

No good process is static. Approaches work for a while, sometimes even a long while, and then don't. Markets change. People change. Trends change. Stuff happens. As Nobel laureate Robert Shiller recently told Institutional Investor magazine, big mistakes come from being "too formulaic and bureaucratic. People who belong to a group that makes decisions have a tendency to self-censor and not express ideas that don't conform to the perceived professional standard. They're too professional. They are not creative and imaginative in their approach."

Poor decision-makers tend to see things though one analytical lens. That's why pundits, who typically see the world through a specific ideological prism, have such demonstrably lousy track records. Good decision-makers use a wide assortment of analytical tools, seek out information from diverse sources (using "outside" sources is especially important), are comfortable with complexity and uncertainty and are decidedly less sure of themselves.

"Given the impressive power of this simple technique, we should expect people to go out of their way to use it. But they don't," says Harvard psychologist Daniel Gilbert. The reason why is clear, according to Michael Mauboussin: Most of us think of ourselves as different, and better, than those around us, especially in our supposed areas of expertise. Moreover, we are prone to see our situation as unique and special. But in almost all cases, it isn't.

Going through the effort consistently and comprehensively to check our work and improve our processes requires extraordinary organizational patience, but the stakes are high enough to merit such a long-term investment.

As in every field, those who make poor decisions propose all sorts of justifications and offer all kinds of excuses. They insist that they were right but early, right but gob-smacked by the highly improbable or unforeseeable, almost right, mostly right or wrong for the right reasons. As always, such nonsense should be interpreted unequivocally as just-plain-wrong.

Decision Rules

A quick summary of some of the (often overlapping) ways research has shown that we can improve our judgment follows.

• Make sure every decision-maker has positive and negative skin in the game.

• Focus more on what goes wrong and why than upon what works (what Harvard Medical School's Atul Gawande calls "the power of negative thinking").

• Make sure your investment process is data-driven at every point.

• Keep the investment process as decentralized as possible.

• Invoke a proliferation of small-scale experimentation; whenever possible, test the way forward, gingerly, one cautious step at a time.

• Move and read outside your own circles and interests.

• Focus on process more than results.

• Collaborate—especially with people who have very different ideas (what Kahneman calls "adversarial collaboration").

• Build in robust accountability mechanisms for yourself and your overall process.

• Slow down and go through every aspect of the decision again (and again).

• Establish a talented and empowered team charged with systematically showing you where and how you are wrong. In essence, we all need an empowered devil's advocate (as I wrote in December).

• Before making a big decision, conduct a "pre-mortem" in order to legitimize and empower the doubters. Gather a group of people knowledgeable about the decision and provide a brief assignment: "Imagine that we are a year into the future. We implemented the plan as it now exists. The outcome has been a disaster. Take 10 minutes to write a brief history of that disaster. Discuss."

Dalbar's latest conclusion suggests that individual investors shouldn't be expected to help themselves. That reality provides advisors with a tremendous and important opportunity. But unless and until advisors improve their own decision-making skills, the opportunity will necessarily be squandered. There is simply no substitute for good judgment. But it remains in remarkably short supply.