In December of 2008, Stephen Greenspan, a developmental psychologist, published The Annals of Gullibility, the first comprehensive academic treatment of why people are gullible.

A few days later Bernie Madoff’s Ponzi scheme was revealed, a crime for which he is now serving a 150-year prison sentence.

Unrelated?  Not quite.  Greenspan was one of Madoff’s victims.  He had a third of his retirement savings invested with Madoff.

Michael Mauboussin

Michael Mauboussin

Smart people – those who should know better, including some of the smartest people around – make horrendous mistakes.   That was the case with Greenspan.  It was also the case with the Nobel Prize-winning economists who ran Long Term Capital Management and with NASA’s rocket scientists responsible for launching the space shuttle Challenger despite known problems with its foam insulation.

Each of those failures was characterized by its own unique flaw – excessive hubris, narrow-mindedness, or insufficient research.  Together, though, they illustrate the potentially devastating effects of a sub-optimal decision-making process.

“When faced with critical decisions, our minds naturally want to go down one path, when a better way to think about the problem is to go down another path,” said Michael Mauboussin.  Mauboussin is the Chief Investment Strategist at Legg Mason Capital Management and the author of the newly released book Think Twice

Mauboussin’s book is dedicated to stopping you from making costly mistakes, and he discussed a number of specific mistakes applicable to investors and advisors speaking at a luncheon in Boston on April 8.

Taking the inside view

After convincingly winning the Kentucky Derby and the Preakness Stakes in 2008, the thoroughbred Big Brown became an overwhelming favorite to win the third jewel in racing’s Triple Crown, the Belmont Stakes.   His trainer claimed it was a “foregone conclusion” that he would win the race, and he went off at 3-to-10 odds, which implied he had a 77% chance of winning.

He didn’t win. In fact, he was the first Triple Crown contender to finish dead last in the Belmont.