Annotations (22)
“When you are thinking about any kind of forecast, it is incredibly important to understand and acknowledge the reference class from which this problem comes, and to weight your own views with the evidence you have from the reference class. An analyst suggested Amazon would grow revenues 15 percent a year through 2025. The outside view, the base rate, looked at every company with initial revenues of $100 billion or more since 1950.”— Michael Mauboussin
Strategy & Decision Making · Psychology & Behavior · Economics & Markets
DUR_ENDURING
Weight inside view with reference class
“Burke and Green recommended a different way of evaluating managers. They said the way to think about it is gross return of the manager, pre-fee, risk-adjusted, minus their benchmark, times assets under management. How much value can that manager extract from the market in dollars? Peter Lynch in his first five years running Magellan had amazing alpha but was running a puny amount of money. His monthly gross profit was $770,000.”— Michael Mauboussin
Business & Entrepreneurship · Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Dollar alpha better metric than percentage
“Stephen Jay Gould argued that Ted Williams hitting .400 in 1941 was exactly a four standard deviation event. By 2016, a four standard deviation event would get you to about .380. The difference between the very best and the average has decreased because the standard deviation has gone down over time. There is more uniform excellence.”— Michael Mauboussin
Economics & Markets · Psychology & Behavior · Strategy & Decision Making
DUR_ENDURING
Skill improves uniformly, making luck more important
“When both luck and skill contribute to outcomes, as skill gets better, luck becomes more important. Absolute skill has never been better in investing. If I gave you all the technology at your fingertips today and put you back in the 1960s or 1970s, you would crush the competition. But relative skill, the difference between the very best participant and the average participant, has been going down. The variance has been shrinking.”— Michael Mauboussin
Strategy & Decision Making · Economics & Markets
DUR_ENDURING
Better absolute skill narrows relative skill
“Brian Arthur at Stanford did work on increasing returns. We are taught in microeconomics that returns, marginal returns, tend to migrate towards the cost of capital. High return on capital businesses attract competition, which drives returns down. Brian identified situations called increasing returns where there was no regression toward the mean. There was actually a repulsion from the mean. Winners were winning. Losers were losing. He identified qualities and features like network effects.”— Michael Mauboussin
Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Some systems repel from mean, not regress
“John Geanakoplos at Yale wrote papers on the leverage cycle. His very provocative point is that it is not about interest rates. It is about margin requirements. It is about the ability to borrow. We tend to think that if we lower interest rates the world is going to be better, and we raise interest rates going to be tight. He is saying that is not really the key thing. It is the collateral.”— Michael Mauboussin
Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Margin requirements matter more than rates
“While we talk a lot about diversity, which is almost always social category diversity (race, gender, age, ethnicity), the real key is cognitive diversity. People with different experiences, backgrounds, training, and personalities that can surface different points of view. That is really the key to good quality decision making. A typical investment committee says we are going to have the credit guy, the private equity gal, and so forth.”— Michael Mauboussin
Leadership & Management · Strategy & Decision Making · Psychology & Behavior
DUR_ENDURING
Cognitive diversity beats social diversity
“There is an element of career risk. Bill Belichick goes for it on 4th down and it does not work out. People give him the benefit of the doubt. But if you are a coach with a .500 team, it may be the correct decision but you lose that game. People do not think about the quality of your decision-making process; they think about the outcome. These guys might be saying, if I punt it, we may lose the game, but no one is going to say Ted punted, that was bad.”— Michael Mauboussin
Psychology & Behavior · Strategy & Decision Making · Leadership & Management
DUR_ENDURING
Reputation preserves mediocre decisions
“Once you start thinking about markets as complex, adaptive systems, I do not think you can ever think about them in any other way. Markets as complex, adaptive systems both explains why markets tend to be efficient (wisdom of crowds) but also explains why markets episodically go haywire, which they clearly do. The fact that you and I are suboptimal does not necessarily translate into a market setting because our errors may cancel out. You are overconfident and buy. I am overconfident and sell.”— Michael Mauboussin
Economics & Markets · Biology, Ecology & Systems · Psychology & Behavior
DUR_ENDURING
Markets are complex adaptive systems
“Keith Stanovich made an important distinction between IQ, which measures some very real helpful things, and what he calls RQ, rationality quotient, which is the ability to make good decisions. About a year ago he published The Rationality Quotient with colleagues, laying out for the first time an assessment of rational thinking. Find people with weird backgrounds but assess them on their ability to think rationally. That combination might be the sweet spot for success.”— Michael Mauboussin
Psychology & Behavior · Leadership & Management
DUR_ENDURING
Rationality quotient over IQ for decisions
“There is an incredible literature demonstrating that people tend to have bad timing. The number one reason you fire a manager is their performance has been poor. The number one reason you hire a manager is performance has been good. Study after study demonstrates that if you bought the funds that were fired and sold the ones that were hired, you actually do much better because of regression toward the mean.”— Michael Mauboussin
Psychology & Behavior · Strategy & Decision Making · Economics & Markets
DUR_ENDURING
Hiring and firing based on performance fails
“Sandy Grossman and Joe Stiglitz in 1980 wrote a paper called On the Impossibility of Informationally Efficient Markets. Their basic argument was markets cannot be perfectly informationally efficient because there is a cost to gather information and reflect it in prices. As fair compensation to assume that cost, there should be a requisite benefit. Lasse Pedersen calls it markets have to be efficiently inefficient.”— Michael Mauboussin
Economics & Markets · Philosophy & Reasoning
DUR_ENDURING
Efficiency requires compensatory inefficiency
“The number one way we use to compare things is by analogy. This is like that. That approach is incredibly effective if you have got the appropriate analogy. But it breaks down pretty quickly in terms of breadth and depth. Breadth: you might have a great memory, but it is probably finite, so you may not remember the appropriate analogy or know of it. Depth: you may pick the wrong things, the wrong features of both the full goal and the analogy to make an appropriate comparison.”— Michael Mauboussin
Psychology & Behavior · Philosophy & Reasoning
DUR_ENDURING
Analogies fail on breadth and depth
“Richard Hackman studied teams across all different disciplines and found the optimal size was four to six. Every person on a committee of seven or more says we would be more effective if we were smaller. Nothing is happening at a board meeting with 25 people. All the work is happening at the committee level, the small groups.”— Michael Mauboussin
Leadership & Management · Operations & Execution
DUR_ENDURING
Optimal team size four to six people
“The standard deviation of excess returns, the standard deviation of alpha, has been getting skinnier over time. The people drawn to this industry are today extremely well educated, very well-trained, with access to incredible information and academic research. The degree of uniformity of excellence is probably higher, making it more difficult to distinguish yourself.”— Michael Mauboussin
Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Better training shrinks alpha distribution
“Kahneman has this line in Thinking Fast and Slow: people who are doing their own work do not feel like they need to understand the reference class. But understanding the reference class almost always makes you a better thinker. We tend to be overconfident. Our ranges of outcomes are too narrow. Confirmation bias: you make a decision, you seek information that confirms your point of view, and you dismiss, disavow, discount information that does not. It is a very natural thing for all of us to do.”— Michael Mauboussin
Psychology & Behavior · Strategy & Decision Making
DUR_ENDURING
Overconfidence and confirmation bias universal
“AlphaGo and AlphaZero are mindboggling. The advancements in how those things became superhuman were expected. But more interestingly, great go players and chess players say these programs are playing moves that were not even in our mental repertoire, and we are learning from them. Some of these moves in retrospect are really beautiful. It is opening up our mental space.”— Michael Mauboussin
Technology & Engineering · Creativity & Innovation · Psychology & Behavior
DUR_CONTEXTUAL
AI discovers moves beyond human conception
“In Big Data Baseball, the thing that blew me away was pitch framing. Catchers can position themselves to catch pitches in such a way that the umpire calls it a strike instead of a ball. Some catchers are better at it than others. Simply bringing in a catcher who is really good at pitch framing can lead to a substantial delta in the number of games won over a season. That is a perfect example of analytics and the human dimension.”— Michael Mauboussin
Operations & Execution · Psychology & Behavior
DUR_ENDURING
Invisible skill creates measurable edge
“I am very committed to mental models and thinking about big mental models. I am a huge fan of understanding big ideas from different disciplines, understanding that constant learning will lead you down a number of intellectual cul-de-sacs, but you never know when a framework or model or something will be useful to you. This idea of constant learning. In this industry you cannot live without it. How can Todd Combs and those guys make such big decisions in short periods of time?”— Michael Mauboussin
Philosophy & Reasoning · Strategy & Decision Making
DUR_ENDURING
Mental models enable fast decisions
“Most good investment ideas are controversial. It is very rare that everyone says this is obviously brilliant. I am a big fan of ballot voting systems. Maybe strong majority, but majority ballot voting systems. Let people vote independently.”— Michael Mauboussin
Strategy & Decision Making · Leadership & Management
DUR_ENDURING
Ballot voting prevents groupthink
Frameworks (2)
Dollar Alpha Framework
Asset-Weighted Manager Evaluation
Framework for evaluating active managers based on dollar value extracted from markets rather than percentage alpha. Calculates gross profit as (gross return minus benchmark) times assets under management. Reveals that managers with declining percentage alpha can still extract more total value as AUM grows, similar to playing poker at higher stakes with lower edge.
Components
- Calculate Gross Alpha
- Multiply by Assets Under Management
- Compare Across Time Periods
Prerequisites
- Access to historical returns data
- Benchmark comparison methodology
Success Indicators
- Better understanding of true manager value-add
- More nuanced capacity decisions
Failure Modes
- Overweighting dollar alpha in small AUM situations
- Ignoring strategy-specific capacity constraints
Base Rate Forecasting
Inside-Outside View Integration
Decision-making framework that weights specific case analysis (inside view) with historical reference class data (outside view or base rates). Prevents overconfidence by anchoring predictions to what actually happened in similar situations historically, then adjusting based on unique case factors.
Components
- Define the Reference Class
- Gather Base Rate Data
- Analyze the Inside View
- Weight and Integrate
Prerequisites
- Access to historical data
- Willingness to challenge intuitive judgments
Success Indicators
- Better calibration of predictions
- Reduced overconfidence in forecasts
Failure Modes
- Choosing unrepresentative reference class
- Insufficient adjustment for truly unique factors
Mental Models (8)
Paradox of Skill
Strategic ThinkingWhen both luck and skill contribute to outcomes, increasing absolute skill levels can make luck more
In Practice: Mauboussin explaining Stephen Jay Gould's spread of excellence concept applied to investing
Demonstrated by Leg-mm-001
Efficient Inefficiency
EconomicsMarkets must maintain enough inefficiency to compensate those who gather and process information, creating an equilibrium where opportunities exist but are difficult to exploit. Perfectly efficient markets would collapse because no one would pay the cost to make them efficient.
In Practice: Reference to Grossman-Stiglitz and Pedersen's work on market efficiency paradox
Demonstrated by Leg-mm-001
Inside-Outside View
Decision MakingDecision-making approach that combines case-specific analysis (inside view) with statistical base rates from similar historical situations (outside view). Start with the base rate as anchor, then adjust based on unique case factors.
In Practice: Kahneman's reference class forecasting applied to Amazon growth projection
Demonstrated by Leg-mm-001
Overconfidence Bias
PsychologySystematic tendency to overestimate one's knowledge, abilities, and the precision of one's beliefs.
In Practice: Mauboussin discussing universal cognitive biases
Demonstrated by Leg-mm-001
Confirmation Bias
PsychologyTendency to seek, interpret, and remember information that confirms pre-existing beliefs.
In Practice: Discussion of biases that persist even when known
Demonstrated by Leg-mm-001
Regression to the Mean
TimeStatistical phenomenon where extreme outcomes are likely to be followed by more
In Practice: Why buying fired managers and selling hired managers works
Demonstrated by Leg-mm-001
Increasing Returns
EconomicsEconomic dynamics where winners accumulate advantages that lead to more winning rather than regression to the mean. Characterized by network effects, learning curves, and positive feedback loops. Contradicts traditional microeconomic assumption of diminishing returns.
In Practice: Brian Arthur's work at Santa Fe Institute on non-equilibrium economics
Demonstrated by Leg-mm-001
Complex Adaptive Systems
Systems ThinkingSystems composed of heterogeneous agents whose interactions produce emergent pro
In Practice: Mauboussin's transformation in understanding markets through Santa Fe Institute
Demonstrated by Leg-mm-001
Connective Tissue (3)
Markets as complex adaptive systems like biological ecosystems
Complex adaptive systems consist of heterogeneous agents (neurons, people, investors) who interact, producing emergence (consciousness, cities, markets). In biological ecosystems, individual organisms are suboptimal but the system exhibits remarkable efficiency through selection. Similarly, markets show efficiency through the wisdom of crowds despite individual investor irrationality. But just as ecosystems episodically collapse, markets go haywire. The adaptive part is crucial: agents modify their behavior based on the environment, creating feedback loops. When you are overconfident and buy while I am overconfident and sell, our individual biases cancel at the system level. This framework explains both market efficiency and periodic breakdowns better than either efficient market hypothesis or behavioral economics alone.
Mauboussin describing why complex adaptive systems thinking changed how he views markets
Ted Williams .400 batting average as four standard deviation event
Stephen Jay Gould analyzed the disappearance of .400 hitters in baseball using statistical distribution analysis. Ted Williams' 1941 .400 average was exactly four standard deviations from the mean. By 2016, the standard deviation of batting averages had shrunk such that four standard deviations would only reach .380. The parallel to investing: as absolute skill improves uniformly across all players, the variance in outcomes decreases. In baseball, this means no .400 hitters. In investing, it means smaller dispersion of alpha among managers. Both are examples of the paradox of skill, where rising absolute skill paradoxically makes luck more important to outcomes by reducing the relative skill gap between best and average.
Mauboussin explaining why active management performance has compressed
Baseball pitch framing as invisible skill factor
Big Data Baseball revealed that catchers can influence umpire strike calls through pitch framing technique, positioning their glove to make borderline pitches appear as strikes. Some catchers are measurably better at this skill than others, creating substantial differences in team win rates over a season. The parallel to investing: hidden factors that are measurable with data but invisible to traditional analysis can create significant edges. Just as pitch framing was not captured in traditional baseball statistics but creates real value, investment factors like operational alpha in private equity or trade execution quality in public markets may be invisible in headline metrics but material to outcomes. The key insight is the combination of analytics revealing the invisible factor with human skill executing it.
Discussion of how data analytics in sports reveals previously hidden value drivers
Key Figures (14)
Stephen Jay Gould
3 mentionsEvolutionary Biologist, Harvard
Late evolutionary biologist who wrote Full House (1996).
- Ted Williams hitting .400 was exactly a four standard deviation event
Daniel Kahneman
2 mentionsPsychologist, Nobel Laureate
Jonathan Burke
2 mentionsFinance Professor
Brian Arthur
2 mentionsEconomist, Santa Fe Institute
Peter Lynch
1 mentionsFund Manager, Fidelity Magellan
Keith Stanovich
1 mentionsPsychologist
Richard Hackman
1 mentionsHarvard Professor
Todd Combs
1 mentionsInvestment Manager, Berkshire Hathaway
John Geanakoplos
1 mentionsEconomist, Yale
Geoffrey West
1 mentionsPhysicist, Santa Fe Institute
Bill Belichick
1 mentionsNFL Head Coach
Sanford Grossman
1 mentionsEconomist
Joseph Stiglitz
1 mentionsEconomist
Lasse Pedersen
1 mentionsFinance Professor
Glossary (1)
cul-de-sac
FOREIGN_PHRASEDead end street or unproductive path
“Constant learning will lead you down a number of intellectual cul-de-sacs”
Key People (14)
Stephen Jay Gould
(1941–2002)Evolutionary biologist, Harvard professor, author of Full House
Joe Stiglitz
(1943–)Nobel Prize economist
Sandy Grossman
(1953–)Economist who co-authored 1980 paper on market efficiency
Lasse Pedersen
(1972–)Finance professor who coined efficiently inefficient
Peter Lynch
(1944–)Legendary Fidelity Magellan fund manager
Jonathan Burke
Finance professor
Daniel Kahneman
(1934–)Nobel Prize psychologist, expert on judgment and decision-making
Richard Hackman
(1940–2013)Harvard professor who studied team effectiveness across disciplines
Keith Stanovich
(1950–)Psychologist who distinguished IQ from rationality quotient RQ
Bill Belichick
(1952–)New England Patriots head coach, six-time Super Bowl winner
Brian Arthur
(1945–)Economist at Santa Fe Institute, pioneer of increasing returns theory
Geoffrey West
(1940–)Physicist, former Santa Fe Institute president, author of Scale
John Geanakoplos
(1955–)Yale economist known for work on leverage cycles and collateral
Todd Combs
(1971–)Concepts (12)
Paradox of Skill
CL_STRATEGYAs absolute skill improves, luck becomes more important because relative skill differences shrink
Alpha
CL_FINANCIALExcess return above benchmark, measure of manager skill in generating returns
Informationally Efficient Markets
CL_ECONOMICSMarkets where prices fully reflect all available information instantaneously
Gross Profit (asset management)
CL_FINANCIALManager pre-fee excess return times assets under management, dollar value extracted
Base Rates
CL_PSYCHOLOGYHistorical frequency of outcomes in a reference class of similar situations
Confirmation Bias
CL_PSYCHOLOGYTendency to seek information confirming beliefs while dismissing contradictory information
Overconfidence
CL_PSYCHOLOGYCognitive bias where people overestimate knowledge, ability, and precision of beliefs
Cognitive Diversity
CL_PSYCHOLOGYVariety in thinking styles, experiences, backgrounds, and problem-solving approaches
Regression to the Mean
CL_ECONOMICSStatistical phenomenon where extreme outcomes tend to be followed by more moderate outcomes
Increasing Returns
CL_ECONOMICSEconomic dynamic where winners accumulate advantages leading to more winning, not mean reversion
Complex Adaptive Systems
CL_SCIENCESystems of heterogeneous agents whose interactions produce emergence and who adapt behavior
Leverage Cycle
CL_ECONOMICSCredit cycle driven by changes in collateral requirements rather than interest rates
Synthesis
Synthesis
Migrated from Scholia