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How the Scientific Method Can Make You a Better Investor

Most individual investors fail to beat the market because they let emotion and intuition take the wheel. But with a good framework for navigating their decisions, individuals can learn to identify and ignore their emotional biases to make calmer, more rational choices with their money.

On this week's Industry Focus: Healthcare, Kristine Harjes and Todd Campbell share how, for more science-minded investors, the scientific method can help take the emotion out of decisions. And, they illustrate how with two examples from this week's news -- Illumina's (NASDAQ:ILMN) 22% crash after they reduced their 2016 growth estimates, and UnitedHealth Group's (NYSE:UNH) decision to leave the Obamacare exchanges.

A full transcript follows the video.

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This podcast was recorded on April 20, 2016.

Kristine Harjes: Why thinking like a scientist can make you a better investor on this healthcare episode of Industry Focus.

It is April 19th, welcome to Healthcare Industry Focus! I'm your host, Kristine Harjes, and I've got Todd Campbell on the line. Todd, how's it going?

Todd Campbell: It's going very well. Glad to be here.

Harjes: Good, glad to have you as always. Gaby Lapera and John Maxfield did a show on Industry Focus last Monday, April 11th about writing and how learning to be a good writer helps you with your investing. We got a lot of really great feedback about that episode. It is a great one, so make sure to give it a listen if you haven't already.

I have to say I have always been more of a math nerd than an English nerd. I had this idea. Fortunately, Todd was onboard with me here. We want to make the argument for thinking like a scientist in your investing and how it can help you make better financial decisions.

We'll start out by talking a little bit about the overlap between science and investing. Then we'll do some more healthcare specific stuff. Sound like a plan, Todd?

Campbell: I think that's a great way to approach it. Listeners, don't get too nervous here. You're not going to need to be a scientist to be able to invest in healthcare. We're just going to walk you through some thoughts, things that we think that could help you in your process.

Harjes: Yeah, this is definitely more of a high-level episode as opposed to, "Well, if you're looking at this clinical trial data and you see a p-value that doesn't correlate with you ...." We're not going to bog you down with that, so, no worries.

Todd, when we were chatting earlier, you mentioned Adam Grant, who, I was really excited when I saw your note about him because I actually just read his book, Originals. He has a lot of really great thoughts about thinking like a scientist and how to best use a really empirical framework in making decisions. Did you want to talk a little bit on him?

Campbell: Yeah, he was just at Motley Fool HQ wasn't he?

Harjes: Yeah, he gave a really, really fascinating talk.

Campbell: Yeah, what struck me about him, or what reminded me was we were doing the work leading up to this episode. I was listening to the podcast that he had recorded when he was there. It was a fascinating discussion, because it talked a lot about how we come to make our decisions.

Harjes: Yeah, we get emotional, as humans, about a lot of things and we know, in investing, that time and time again individual investors often lose to the broader market because they let their emotions get tied up in their decision making. As Adam Grant points out, trusting your gut only really works when you're an expert working in your field of expertise. Outside of that, you're better off following more of a structured, methodical way of thinking.

Campbell: Right, it's all about process. If you have a process that's repeatable, something that you can put into place and continually refer back to and then use time and time again, eventually maybe you'll get that experience level where you can rely on your gut, but yeah, investing with your gut, especially in healthcare where there's a lot of nuances, especially in biopharma, yeah, it's good to have a process that you can spell out and walk your way through.

Harjes: Right, so that process, of course, and we're talking about science, is the scientific method. It's just a very elementary concept. I think I probably learned it first in elementary school, but it is so robust and so useful that it's something I still use to this day in my investing and outside of that.

I'll just start walking us through what this scientific method is. There are some very clear steps to it. Then, maybe we can talk about how it relates, particularly, to investing.

First things first. When you're looking at the scientific method, you need to ask a question. If you are an observant person, which hopefully you are, you're going to be picking up new ideas all the time, learning things from the world around you and you're going to hear these ideas about new industries, and new companies. Maybe you see something in the news, or on a podcast and as an investor, you're asking, "Is this a good place for my money?" There's your question, "Do I want to invest in X?"

Campbell: Right, and you know the other thing to add to that, too, Kristine, is if you can be more specific when you're asking your question, even better.

Harjes: That's a great point.

Campbell: Asking the question, "Is Celgene likely to go higher?" Maybe you're not going to be able to narrow that down quite as easily as maybe if you could say, "Will Otezla, their autoimmune disease drug, see their sales grow over the course of the next 52 weeks?"

Harjes: Once you have that question in mind and I really like your commentary there that the more specific, the better, you need to do some research. You need to understand what are some of the competitors in this space, or what is the industry all about to begin with? You want to make sure that you have that solid...