In Michael Mauboussin’s book, Think Twice: Harnessing the Power of Counterintuition, there’s a great passage on how investors can make better investment decisions using what he terms a ‘premortem’. Here’s an excerpt from the book:
Many people are familiar with a postmortem, an analysis of a decision after the outcome is known. For example, teaching hospitals hold morbidity and mortality conferences in order to review mistakes in patient care and to modify processes of decision making. But Gary Klein, a psychologist, suggests what he calls a premortem, a process that occurs before a decision is made. You assume you are in the future and the decision you made has failed. You then provide plausible reasons for that failure.
Work done by Deborah Mitchell and colleagues in late eighties found that prospective hindsight– imagining the future outcome today — increases the ability to reason for future outcomes by 30 %. The method of prospective hindsight analysis for failure of a given project is called pre-mortem. A pre-mortem in a business setting comes at the beginning of a project so as to improve the success outcome for the project as opposed to post-mortem, an autopsy of failure.
Ben Carlson in his post on portfolio pre-mortem asks the following:
To prepare for the risks that are outside of your control, here are a few considerations for your portfolio premortem:
What will I do and how will I feel if stocks reverse from these levels and fall 10%, 20% or 30%?
What will I do and how will I feel if stocks continue to rise another 10%, 20% or 30%?
How much money am I willing to lose in my portfolio before I become uncomfortable and act irrationally?
How will I react if my future portfolio performance is lower than expected?
How will I react if my future portfolio performance is higher than expected?
Does my investment plan take into account the fact that I will be wrong from time to time? Guy Kawasaki mentions the premortem idea which he summarizes in this two-minute video from one of his Stanford Business School lectures.
It is relatively easy to invest. If you invest yourself, there are many platforms you can use. They make investing simple. If you use a wealth manager or similar, it’s easy. You delegate to them and they get on with it. Easy.
Whilst investing is easy, being a successful investor is hard.
Using a pre-mortem helps minimise the risks and ensures you increase the chances of better outcomes. And if you are already invested, it doesn’t matter, you apply all the principles and it will guide you to make better decisions.
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