What does Google’s hiring and personnel practices have to do with investing? Much more than I ever expected.

I guess that I shouldn’t have been surprised. The inside jacket of the book mentioned that the author draws on “the latest research in behavioral economics and a profound grasp of human psychology.”

The author in question is Laszlo Bock, the head of the Google’s “People Operations”. The book is “Work Rules!” It’s worth a read, for both business leaders and investors.

Let me share with you some of the parallels between Google’s employment experiences and sound principles of investing.

Hire Slowly

The most distinctive features of Google’s recruiting process is the amount of time and resources they put into it. Google is convinced that hiring extraordinary people is the most important thing that they do. Google has seen over and over again how extraordinary employees can deliver extraordinary value to the shareholders of Google.

Google also understands the profound cost of hiring the wrong person for the job. A bad hire isn’t just about the money Google loses on paying salaries to the ineffective team member. It also can impact team morale and productivity, consume management resources and result in missed opportunities that a better hire might have created.

Google believes that not filling a position is vastly better than filling a position with the wrong person – whether the position is an administrative assistant or a VP.

As investors we can learn a lot from Google’s care and caution around the “buying” process. Like Google we should be extremely careful about the investments that we allow into our portfolios. Just like great people can contribute great value to companies in ways never imagined, great investments can add more value to our portfolios than ever imagined. Great investments can, of course, have great ROI but they can also lead us to new ideas for other great investments and they can build our confidence as investors.

And I probably don’t need to tell you at this point how devastating it can be to let one bad apple rot in a portfolio.

Don’t Trust Your Gut

A little over a decade ago, two psychology students, under the guidance of their college professor, made the stunning discovery that the outcome of most hiring interviews could be accurately predicted in the first ten seconds of the interview.

To figure this out, the graduate students videotaped real interviews and then asked study participants to watch the first 10 seconds of the interview and then predict whether or not the candidate was hired. Incredibly, the immediate impression based on a handshake and brief introduction predicted the outcome of a structured employment interview more often than not.

Whatever happened over the following hour or two didn’t matter as much as what happened in the first ten seconds of the interview. In fact, after the first 10 seconds, the interviewers spent the rest of the time looking through the rose colored glasses of their first impression. They sifted through all of the information that followed the first 10 seconds, giving preference to the information that confirmed their initial impression and discounting information that contradicted their first impression.

This is classic “confirmation bias” – favoring evidence that supports our initial impression while giving less significance to information that calls into question our initial impression.

It would be one thing if these “snap-judgements” we make turned out to be accurate assessments but it unfortunately isn’t the case. It’s not that there is no valuable information in a first impression. First impressions should be part of the decision making process but they shouldn’t be used to disregard additional information that doesn’t support our first impression.

Wikipedia defines confirmation bias as “the tendency to search for, interpret, favor, and recall information in a way that confirms one’s beliefs or hypotheses.”

Confirmation bias is a BIG problem for investors too.

We constantly view our investments and potential investments through rose-colored glasses. We favor information that reinforces our assumption that we made a good choice, that we’re intelligent, that we’re going to be successful, etc. That’s a big part of what makes it tough to sell a stock that has hit its trailing stop.

Some remedies for confirmation bias are:

  1. Self-awareness: you need to know that you do this and you need to watch out for it. It can be fun to watch your biases and see how they influence your decisions. Developing self-awareness around these issues can be very empowering and lead to better decision making in other areas of life as well.
  2. Data: Google is obviously very good with data and they use that capacity to help them improve their hiring processes as well. They collect data on their decisions and their outcomes and they go back and review it. As investors, we could keep a journal of our investment decisions and look back periodically at our choices.
  3. Consistency: Google uses a structured set of interviewing questions as one part of their hiring strategies. Having a structured and consistent set of questions that every candidate has to respond to can be a good way to help the interviewers to not let their biases take the interview in a “self-confirming” direction. For investors, we can use a disciplined investment strategy to help temper our confirmation biases by being consistent.

Do You Have Enough Data Points?

As human beings we are constantly looking to link cause with effect. We have a need to explain to ourselves the things that are going on around us – even if we don’t have very many data points. We constantly try to draw conclusions based on small, and often flawed, samples that we happen to see. It’s a nearly irresistible tendency in us.

Google noticed this particularly when it came to performance and promotion. Some staff felt like Google wasn’t doing enough to deal with poor performers and that promotions were more likely if one had worked on certain favored projects or with certain executives.

The data didn’t support such conclusions but when it comes to sample bias, most people don’t take the time to ask for the data.

Bock relates a great example of sample bias from a study commissioned by the U.S. military during World War II. Hungarian mathematician and statistician Abraham Wald was asked to help the U.S. military figure out what it could do to help improve the survival rate for its bombers.

Wald immediately set out to study the location of the bullet holes in all of the bombers when they would come back from their missions. He hoped to determine where more armor would be most useful on the planes.

His research showed that the planes were most damaged in the wings, nose and fuselage while not suffering as much damage around the cockpit and tail.

So where did he conclude the planes needed to be most reinforced? Around the cockpit and tail. Wald understood that he was looking at a sample of the planes and not all of the planes. The sample he looked at had undamaged cockpits and tails and they were the ones that made it back home. He correctly concluded that protecting the cockpit and tail were the most important thing that the military could do to improve the survival rate of its bombers.

As investors we are constantly indulging in sample bias. Price goes up one day and we think that it means something. It goes down the next day and we think that it means something else. Daily price movements are meaningless in the vast majority of cases. It takes a much larger sample of prices for a meaningful pattern to emerge. That doesn’t stop most of us, however, from reading the financial headlines in search of explanations for short-term price moves. The media makes a ton of money off of our sample bias.

Focusing on the Two Tails

There were several more very compelling “people” observations from Google that had direct relevance to investors. My personal other favorite was what they called “Two Tails”. The “tails” in question are the tails of the bell curve or normal distribution of performance.

Google ranked their employees by performance. Not surprisingly, most employees performed similar to their peers (here called Average Performance) while a few were “low performers” and a few were “high performers.”

Performers
Google found that they got the most value out of helping the Low Performers start to perform more in-line with the rest of their peers as well as by studying their highest performers to learn from them about how to perform at the highest level.

I’ve said for years and years now, for investors our biggest opportunities are in making sure that our low performing investments don’t do us in while also making sure that our highest performing investments have every chance to shine. I am more convinced than ever that it remains the case today.

The Human Resources of Investing

It’s easy to think that investing is just a numbers and information game. It’s easy to forget that as self-directed investors, our own decision making comes into play more often than we’d care to admit.

There is more and more evidence available every day that we don’t always make the best decisions. Insights from behavioral finance and economics are readily accessible to everyone. Some of my favorite sources of such insights are:

  • Thinking Fast and Slow, by Daniel Kahneman
  • Risk Savvy, by Gerd Gigerenzer
  • Predictably Irrational, by Dan Ariely
  • Misbehaving, by Richard Thaler.

I’ll now add Laszlo Bock’s “Work Rules!” to that list.

To the growth of your wealth,

Richard_Signature
Richard M. Smith
CEO, TradeSmith
Founder, TradeStops.com