The Three Components of a Great Investment Process

As Managing Director and Head of Global Financial Strategies at Credit Suisse, Michael Mauboussin advises clients on valuation and portfolio positioning, capital markets theory, and competitive strategy analysis. He has also authored three books -- Think Twice, The Success Equation, and More Than You Know -- and is an adjunct professor of finance at the Columbia Business School, and chairman of the Board of Trustees at the Santa Fe Institute.

Successful investing is a combination of luck and skill, Mauboussin says, not simply a matter of "practice makes perfect." He explains the three components of the investing process -- Analytical, Behavioral, and Organizational -- and why an investor needs to be effective across all three.

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A transcript follows the video.

Koppenheffer: A lot of your more recent work has looked at the difference between skill and luck in everything from sports, to investing, to business. When you're thinking about being an investor, and building skill as an investor, one of the things we've heard -- and Malcolm Gladwell has talked a little bit about this -- is 10 years of deliberate practice. What are ways that investors can go about doing deliberate practice, and gaining that experience?

Mauboussin: This is a super interesting question, because I actually think the deliberate practice model can be somewhat misleading for investing -- or really, any exercise that's probabilistic.

What's the key for deliberate practice? It works in domains where your outcome is very indicative of your skill. If I want to know if you're a good tennis player, Matt, or a good piano player ...

Koppenheffer: To answer the question, I'm both!

Mauboussin: I can watch you or listen to you and, if I know what I'm doing, I can judge that. In fact, as you progress -- if you have a good coach or teacher -- they can help you get better. That's where the deliberate practice, the 10,000-hour stuff, really works well.

But as you slide over and introduce more luck and more probabilities, it becomes much more difficult.

I'll give you a very simple example. Let's say now you go to Atlantic City to play blackjack. Well, there's standard strategy, and you could play correctly and lose for a short period of time, or you could play foolishly, and win. There's a disconnect between, in a sense, your skill and the outcomes.

As a consequence, what I argue is, you need to have a process. For me, an investing process -- to your point -- has three specific components.

One, let's call it Analytical, which is being able to analyze financial statements, understanding future cash flows ... all those sort of analytical tools that we all need to succeed.

The second I'm going to call Behavioral, which is, we all tend to fall for certain types of mistakes, patterns of mistakes. Learn about those things and trying to manage or mitigate them yourself.

The third I'm going to call Organizational. It may be less relevant for an individual -- although it has some applicability for an individual as well -- but certainly organizationally. What's going on in your company, or in your environment, that allows you to be either more successful or less successful?

All three of those factors I think are really important. What you want to do is be as effective as you can across all those. Be a good analytical investor, minimize your behavioral mistakes, and then be in an environment that's conducive to making good long-term decisions.


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