How Investment Advisers Earn Their Keep

Most investment advisers can't beat the market. Good advisers earn their keep, in part, by helping their clients make better decisions.

This train of thought started with a scheduled speaker tomorrow at the Wealth Management and Trust Conference. Legg Mason's Michael Mauboussin, author of "Think Twice, Harnessing the Power of Counterintuition." will talk about the mental blocks that inhibit good decision-making. Forgetting the existance of black swans, for instance.

Or allowing context to influence a decision. An example that would have alarmed Vance Packard involves wine sales. Play German or Italian music in a store that sells mostly French wines and … sales of German or Italian wines soar.

In this NY Times op-ed piece, Joseph Hallinan illustrates the dangers of jumping to conclusions by explaining why some musicians sight-read so easily. They don't read every note; they recognize patterns in strings of notes. Their gift serves them well. But what if there is one wrong note in the printed score? Will they notice?

No, Boris Goldovsky (long a familiar voice on Metropolitan Opera broadcasts) discovered that only a child, looking at the score without preconceptions, could see the misprinted note.

Goldovsky’s experiment yielded a key insight into human error: not only had the experts misread the music — they had misread it in the same way. *** In short, they don’t read; they infer. Moreover, this trait is not unique to musicians: pattern recognition is a hallmark of expertise in any number of fields; it is what allows experts to do quickly what amateurs do slowly.

Goldovsky’s insight offers a useful metaphor for understanding the crisis on Wall Street: Not only did hedge-fund managers, bankers and others misread the danger involved in many of their investments, but they misread them in the same way.

As Paul E. Kanjorski, a former congressman who served on the House Financial Services Committee, put it, “Why does it appear to the general public that all the finest minds in finance missed the most obvious?”

It appears that way because they did miss it.

Unfortunately, most investment advisers are not 10 years old. Fortunately, even grown-up advisers can help their clients avoid emotional decisions and – think twice. When you consider how much investors would otherwise lose buying high and selling low, that impartial second opinion is a bargain.