In two recent articles, Aversion therapy and The cons of pros, we have discussed the dangers of people being overly confident in their own judgement and how experts of every kind can be particularly susceptible in this regard. Tomorrow’s Grand National affords us a topical opportunity to complete a one-two-three on expert overconfidence by focusing on a classic illustration of this behavioural flaw.
For it involves bookmakers, a panel of whom were asked by academics J Edward Russo and Paul Schoemaker, as part of their 2001 bookWinning decisions: Getting it right the first time, to predict the result of a race based on five pieces of data they were told about each horse running in it. The bookies were then asked to repeat the process after they had been told 10, 20 and finally 40 pieces of data.
After each round of predictions, Russo and Schoemaker also asked how confident the bookmakers felt about their calls. As you can see in the chart below, while the bookies’ confidence in the accuracy of their predictions grew with each additional set of data, the accuracy of those predictions did not. Indeed, after they had received the 40 pieces of information, their accuracy actually grew worse.
The experiment is referred to in Michael Mauboussin’s investment classic More than you know: Finding financial wisdom in unconventional places. As he puts it: “Russo and Schoemaker note that we often believe more information provides a clearer picture of the future and improves our decision making. But in reality, additional information often only confuses the decision-making process.”
The above quote features in a passage of the book that considers four principles for decision-making put together by former US treasury secretary Robert Rubin. The first two of the quartet, which is described by Mauboussin as “especially valuable for the financial community”, are: “The only certainty is that there is no certainty” and “Decisions are a matter of weighing probabilities”.
Nothing we would disagree with there then but, here on The Value Perspective, it is Rubin’s final two principles that particularly resonate: “Despite uncertainty we must act” and “Judge decisions not only on results but also on how they were made”. Many decisions – particularly investment ones – will rely on imperfect information but, even so, the chances are they still need to be taken.
In an investment context, this is where a durable, rigorous and repeatable process is of such importance and of course this is what we believe a value strategy to be. Value leads us to focus on things we can know, such as a business’s valuation and its balance sheet – an excellent insight into how risky it is – rather than being seduced by the siren call of additional pieces of information. That is just noise.
Speaking of which, if you are betting on tomorrow’s big race, we wish you the very best of luck but you will have to look elsewhere for predictions as to the winner.