Whether it is a simple extension being built on a house or the bold development of a brand-new railway line, we know two things: both projects will take longer to complete than estimated and will cost more (often a lot more) than budgeted. In How Big Things Get Done, Bent Flyvbjerg – one of the world’s leading experts on megaprojects – and Dan Gardner explore the somewhat puzzling phenomenon of repeated cost and time overruns, and explain how projects can be improved. Although the complex construction of a bridge may seem poles apart from the (relative) simplicity of making an investment decision; they both share a stark vulnerability to the foibles of human decision making. They can both fail in similar ways. What can investors learn from how projects go awry?

It is obvious to see when a project goes wrong – we start with a set of expectations about the finished product, how much it will cost and how long it will take, and those are either met or not. For investment decisions things are a little trickier – good choices can have bad outcomes (and vice-versa). The randomness and noise in financial markets means that we cannot call every decision that fails to outperform or meet it target a failure.

Let’s take an example. Imagine I invest my entire portfolio in a niche thematic fund that has already produced startling returns and holds assets with stratospheric valuations. Over the next three years its ascent continues and it trounces the broader market. Does that mean it was a good decision? No, it was a terrible one, just extraordinarily lucky.

So, if a failed investment decision is not necessarily one where performance disappoints, what is it? One where the odds of success at the point we make the choice are poor. Bad investment decisions can often be seen from the very start. The same can often be said for large projects.

Psychology and Power

Flyvbjerg and Gardner identify two “universal drivers” that separate a successful project from a flop – psychology and power. Investors should be well-versed in the challenges of making good choices whilst battling our behavioural biases. Any decision-making process – whether it be for an investment or project – that does not explicitly attempt to address these is destined for trouble.

While the influence of power seems obvious for major projects – politicians attempting to impact outcomes to suit their personal agenda – it can seem an irrelevance for investors, but it matters. This is particularly true of institutions that can make investment decisions that are tainted by ambitions, hierarchies and misaligned incentives.

The problem of psychology and power is not just that they can dramatically impact the decisions that we make; it is that they are unspoken. Few people would admit that an investment was driven more by our psychology than our analysis, and nobody would ever say that politics played a part. If we don’t acknowledge it, we cannot do anything about it.

Think Slow, Act Fast

One of the foundations of successful projects, according to Flyvbjerg and Gardner, is the ability to “think slow, act fast”. The basic premise is that we should take our time in diligent planning, as getting the planning right dramatically improves the accuracy and speed of the subsequent work. Far better to find problems in the planning stage, than deal with them halfway through a project.

The difficulty is that planning has a stigma attached to it. People want to see action not spreadsheets and PowerPoints, so there is an allure to getting started. Action trumps thinking. Not only this, but individuals with a vested interest in a particular project are also keen to see shovels in the ground – they know that once costs become sunk and commitment is entrenched the ability to turn back is severely compromised.

Acting in haste and repenting at leisure is undoubtedly also a behavioural issue for investors. The nature of financial markets – the stories, the trends, the performance obsession – almost compels us to act immediately. Either we have no particular plan in place, or emotions ride roughshod over the plan we thought we were going to follow. So we act in the moment.

Most investors really don’t need to be acting fast, but if we do it should only be when following a prudent plan of action which is aligned with our goals.     

Why – at the start, middle and end

A common pitfall identified by Flyvbjerg and Gardner in major project work is losing sight of reason it was undertaken in the first place. A project should start with an understanding of why it is being carried out, and that should remain at the forefront of all decision making throughout. It is incredibly easy to imagine how large and time-consuming projects become so complex that everybody involved forgets what they were actually trying to achieve at the start.

Investors can easily forget what the purpose of their investment decisions are. We might begin with a plan to save regularly over 30 years to fund our retirement. Yet three years down the line we are revamping our portfolio because it underperformed the market over the past six months, or because of an article we saw in the weekend newspapers. Living our portfolios day to day, week to week can easily lead to us forgetting the reason that we began investing.

What’s the reference class?

An area where major projects and investment decisions share identical failings is a lack of willingness to understand appropriate reference classes. We tend to think that the situation we face is distinct – nobody has ever built a bridge like this before / this fund manager is uniquely talented. This is the ‘inside view’, where we obsess over the specifics of our circumstance and ignore the lessons that we might learn from the ‘outside view’ – a wide reference class of similar scenarios.  

This is the reason why very few people adjust expectations for the work being undertaken on their house despite being aware of the cost and time overruns suffered by everyone else. It is the same reason people flock to star fund managers despite the poor record of these types of investments (high level of assets / expensive valuations / unsustainable performance). We seemingly cannot help but think that the precise information that pertains to our case is far more valuable than general comparators.

Reference class / outside view thinking is quite dull, we lose the attractions of the compelling narrative and replace them with some dry probabilities. Yet for investing and major project management, dull is likely to win out.  

A failure to learn

Perhaps the real unifying feature of troubled major projects and poor investment decisions is that despite seeing them all around us we don’t learn the lessons. In both cases this is driven by an unwillingness to accept and address the realities of our behaviour, so we keep repeating the same mistakes.

—

https://www.amazon.co.uk/How-Big-Things-Get-Done/dp/1035018934

—
My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).