More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) (Columbia Business School Publishing)

Every once in a while, the Muses conspire to change the things you do.

For years, when asked for a recommendation of an investment book, I responded that "Reminiscences of a Stock Operator" provided insights each time I read it.

The list is now longer. "More than You Know" by Michael J. Mauboussin has been added.

The author, in 50 insightful essays, draws from the latest in behavior economics and cognitive sciences to give the reader invaluable insights into the concepts of risk and choice.

His investment strategies are sound. They draw from creative thinkers as diverse as Warren Buffett and Steven Christ; they borrow from activities and fields as diverse as casino gambling and evolutionary biology.

Mauboussin believes a multidisciplinary approach based on process and psychology offers the best opportunity for long-term investment success. He breaks his book into four sections: Investment Philosophy, Psychology of Investing, Investment and Competitive Strategy and Science and Complexity Theory. Although his essays are insightful, he provides a thorough bibliography to guide future study.

Why the Muses moved to place this book in my hands last week, I do not know. But I am grateful they did. This book is a trove of knowledge and ideas. It is a must-read for anyone who takes their investing seriously.

It is rare to find a book that fundamentally changes how you think about investing, and beyond that, learning. This is such a book.

Mauboussin relies on a simple, but fundamentally non-consensus idea - that finding useful links between disparate fields, rather than focusing exclusively on one discipline, can make you a better investor. His sources range from Darwin to Dr. Seuss, his subjects from physics to ant colonies, but all of them are focused on generating conclusions and tips that will help you beat the market.

More Than You Know builds a comprehensive investment framework in four chapters:

1. "Investment Philosophy" tackles how you should make investment decisions. Focus on process not outcomes, understand that the magnitude of gains and losses trumps their frequency, understand the psychological hang-ups that can lead to bad decisions, and realize sometimes we see patterns where they don't exist.

2. "Psychology of Investing" helps investors identify the pitfalls that prevent us from remaining objective such as stress, circumstance, and bias.

3. "Innovation and Competitive Strategy" teaches investors how to think about industry structures and how they are changed by innovation. In a world of accelerating change, Mauboussin demonstrates the folly of using historical P/Es, how you can profit from mean reversion, and how perception gaps are generated at predictable stages in a company's evolution.

4. Why can a group of people get to the right answer when no individual person actually has the answer? Why do seemingly small scale inputs often lead to massive and disproportional outputs in the stock market? The book's final chapter, science and complexity, answer these questions and posits a new model that is a better predicator of market behavior than standard finance - one that is consistent with empirical findings and can help you understand market moves more clearly.

In 1998, Mauboussin wrote a report On the Shoulders of Giants, drawing its name from Isaac Newton's statement - "If I have seen further it is by standing on the shoulders of Giants." In this report, Mauboussin expounds Charlie Munger's view that investors must possess a variety of mental models drawn from the central tenets of many disciplines in order to be successful. Otherwise, you end up applying the wrong tool to solve a problem, or as Charlie Munger eloquently puts it - "To a man with a hammer, everything looks like a nail."

This book gives you the tools to get to the right answer.

Before one attempts to review "More Than You Know", it is useful to understand the author's background and context. Michael Mauboussin is Chief Investment Strategist of Legg Mason Capital Management. He is on the Board of Trustees of the Santa Fe Institute (SFI) and also teaches Security Analysis at Columbia Business School. Before Legg Mason, Michael was Chief U.S. Investment Strategist at Credit Suisse First Boston. During his career he has studied the objectives, resources and processes of successful investors; He has aggregated best practices of successful companies, competitive strategy, valuation and behavioral finance; He has studied the important principles of the major disciplines: Finance, Psychology, Mathematics, Physics, Philosophy, Biology, Evolution, History, Literature, Social Sciences. Michael has dedicated his career to one objective: The efficient and effective allocation of Financial and Intellectual Capital.

One of Michael's fundamental beliefs, also one of the main themes of "More Than You know", is that to succeed in accomplishing your investment and life objectives, you need to understand the most important principles of the major disciplines: Finance, Psychology, Mathematics, Physics, Philosophy, Biology, Evolution, History, Literature, Social Sciences. This belief is also a driving influence of Legg Mason's investment philosophy, SFI's culture and the Security Analysis class that Michael teaches at Columbia.

One of the barriers to learning the multi disciplinary approach to become a better investor and a better person is knowing how to properly filter the massive amounts of information (good and bad) that is out there. One of the ways to overcome these barriers is to find what I call filter/aggregators: someone with excellent judgment that has found the relevant knowledge, filtered it, and then aggregated the most important insights in one place for you. Examples of filter/aggregators in the investment world are: Bill Miller, Warren Buffett, Charles Munger and Michael Mauboussin. Michael's books (Expectations Investing, More Than You Know) and essays (Consilient Observer, Mauboussin on Strategy) are filled with investment insights, ideas from other disciplines that apply to investing and references to books, studies and essays by other authors.

The purpose of "More Than You Know" is to show how a multi-disciplinary approach to investing can improve investment skills by giving investors fresh perspectives. The book is divided in 4 Parts/Categories: Investment Philosophy, Psychology of Investing, Innovation and Competitive Strategy, Science and Complexity Theory. Each part is made up of about 7 essays that describe major ideas of each category. In the essays Michael uses examples from business, successful investors, other authors, and studies from other disciplines to derive investment insight. Michael gives an appropriate understanding of the insights. In the eventuality that the reader would like to dig deeper, the Notes section on the essays and the Reference section are filled with studies and books by Investors, Scientists, Physicists, Mathematicians, Biologist, ect...

The book is entertaining and provides knowledge that is very relevant to investors. It also makes you think since the perspectives it gives you are differentiated. One example: how studying fruit flies is relevant to the evolution of businesses within industries. Or how stock markets share many of the same features of social insect colonies such as ants.

It is important to observe how homogeneous the money management industry is. Mutual funds, brokers, individual investors, day traders all read the same newspapers, magazines, books; they have mostly two investment philosophies, value and growth; they read the same analyst reports; watch the same news channels. To accomplish your investment objectives and to gain an edge over the market it is necessary to have a differentiated point of view. "More Than You Know" gives you that differentiated perspective.

These thirty short essays offer a view on the financial markets that is informed by a widely read and wide-ranging intellect. At its best this collection will free the reader to view markets differently from ways in which they are accustomed. In particular, general readers not directly involved in the markets may find this book of interest. For others the insights are generally accepted investor truths in no need of further proof.

It is the author's view that the markets are a "complex adaptive system" and an inherently social activity. As such we may better understand their workings by looking at other organized systems in nature. Interconnecting links in nature, patterns of psychological behavior, the imitative activity of ants, the life cycle of the fruit fly, or mathematical "power laws" are viewed for what insights they can provide.

Much of this leads to already accepted ideas. Here are some examples.

A long term perspective is the preferred investment approach. A disciplined strategy ("process") will eventually yield desired results. Too much portfolio turnover is unproductive. Stress is a product of short term thinking. Innovation is a product of information. The rapid flow of information makes it difficult for a company to control its competitive advantage for long. Great growth companies mature through a life cycle and "stall". The pace of company and product life cycles appear to be accelerating. Investors are often their own worst enemies due to built-in biases. The business of investing is often at odds with the interests of the investor. Losses are harder to bear than successes of equal magnitude which tend to be discounted. Crowd behavior, herding, often leads to excesses (Mackay's "the Madness of Crowds"). Still, markets are rational because diverse opinions create a consensus that cancels out individual "errors".

Elsewhere we are left holding the problem. One essay ends with this: "One of the major challenges in investing is how to capture (or avoid) low-probability, high-impact events. Unfortunately, standard finance theory has little to say about the subject".

Recognizing commonly accepted patterns as they exist elsewhere in our world is not enough to make us better investors, innovators, etc. In the end we have heard all this before.

The author is a strategist at a large active-management mutual fund firm, and it shows in a bizarre intellectual oversight that dominates my impression of the book.

Statistics are cited on p. 16 that 2/3rds of actively-managed mutual funds under-performed their indexes over a recent 5-year period, and 3/4ths over 10 years. The author accurately describes Jack Bogle's and Charles Ellis' cogent critiques of the mutual fund industry. He proceeds in the course of the book to recount many results and observations, both from the investment world and other fields, suggesting that markets are efficient enough that efforts to outwit them are not worth the cost. He notes the correlation between low turnover and high performance, and how psychology and social pressure lead investors astray when they try to beat the market. He presents in fact most of the intellectual background that supports low-cost index investing over active management (the key omission being the tax problems caused by actively-managed mutual funds in taxable accounts).

And yet, the book is an attempt (successful in a way) to describe a body of wide-ranging knowledge for use in trying to select investments to beat the market. This internal conflict reaches its most absurd in Chapter 24, describing the remarkable tendancy of collective information to be more accurate than individual experts, even in predicting the future... but where does this lead the author? Not to index funds, which would be the obvious investment application of this idea. Rather, he suggests that "investors who identify companies intelligently using collectives... may gain an investment edge." In other words, he would buy stock in Vanguard (if that were possible), but he wants you to invest your money with his firm!

The author's conflict of interest bubbles closest to the surface in his discussion of his firm colleague Bill Miller's streak of beating the S&P 500 for 15 straight years, as the book went to press in 2006. Miller's feat is remarkable, and his fund now rakes in 1.68% per year from an asset base of $20 billion (vs. 0.20% or less for many index funds). Miller of course has a favorable blurb for the book, and he may in fact be skilled. Academics debate whether his singular performance (among literally thousands of mutual funds) is anything beyond pure chance. The question is, can you count on such outperformance to continue into the future? The author obviously thinks yes... well, good thing he went to press when he did: Miller's fund underperformed the S&P by 9.9% for 2006.

Rick Ferri's and Williams Bernstein's books will be more useful for almost all individual investors.