Created by Rishabh Srivastava, Founder of Loki.ai
This summary was largely done for my own note-taking, sharing it just in case it adds more value to other people.
I have no affiliation whatsoever with anyone in this note. This is a summary largely taken for my own reference, and may contain errors :)
Context
Source URL:
Why is it important: The book talks about the errors one commonly makes in decision making. Being aware of these errors might help me reduce them.
Keywords
Decision Making, Errors, Psychology, Mental Models
Summary
We should be aware of our biases, and should also learn why people make bad decisions. Then, we should codify these learnings into checklists so that we don't ourselves make bad decisions.
To do this, we should use mental models and look at evidence dispassionately — while being aware of our cognitive biases.
You only need to get rich once. Figure out what your goal is and how to get there. And don't take stupid risks that could lead to ruin.
First, figure out what has worked well in the past. Ask:
- What was my original reason for doing something? What did I known and what were my assumptions? What were my alternatives at the time?
- How did reality work out relative to my original guess? What worked and what didn't?
- Given the information that was available, should I have been able to predict hat was going to happen?
- What worked well? What should I do differently? What did I fail to do? What did I miss? What must I learn? What must I stop doing?
Then define your goals, and figure out how to reach your goals. Simplify your decision making process. Use checklists. Only make a few high quality decisions every year.
Be problem-oriented, not method-oriented. Use whatever works. Look for good enough solutions appropriate to the problem at hand, not perfection and beauty
Make "what do do" and "what to avoid" rules. Use as few criteria as possible to make your decisions. Eliminate everything you can. It'll be a great conservator of effort.
Ask: what is my nature? what motivates me? what is my tolerance for pain and risk? what has given me happiness and unhappiness in the past what things and people am I comfortable with? what are my talents and skills? Do I know the difference between what I want and what I'm good at? Where do I have an edge over others? What are my limitations?
Then execute well, and course-correct when you get off track.
Highlights
Introduction
A man who has committed a mistake and doesn't correct it is committing another mistake
If we understand what influences us, we might avoid certain traps and understand why others act like they do. If we learn and understand what works and doesn't work and find some framework for reasoning, we will make better judgements
Charlie Munger: "I believe in the discipline of mastering the best that other people have ever figured out. I don't believe in just siting down and trying to dream it all up yourself. Nobody is that smart."
Darwin: "I think that I am superior to the common run of men in noticing things which easily escape attention, and in observing them carefully. These causes combined have given me the patience to reflect or ponder for any number of years over any unexplained problem. I have steadily endeavoured to keep my mind free so as to give up any hypothesis, however much beloved, as soon as facts are shown to be opposite to it"
Part One: What Influences Our Thinking
Our anatomy sets the limits for our behaviour
Stimulating the amygdala can elicit intense emotional reactions
High levels of dopamine are increase feelings of pleasure and relieve pain. Serotonin is linked with mood and emotion. Too much stress can lead to low levels of serotonin and low levels are associated with anxiety and depression.
The brain continually changes as a result of our experiences.
Additionally, our state of mind can influence our biochemistry and immune system. The placebo effect is real.
If people think something will go wrong with their health, it often does
Evolution selected the connections that produce useful behavior for survival and reproduction
Mutations cause variations:
1) Competition and environmental change: In most specifies, there are always more offspring born than can survive to adulthood and reproduce, because many children die when yound
2) Individual variability: Within a species, there is an enormous amount of individual variation
3) The world is not fixed but evolving. Species change, new ones arrive, and others go extinct
When organisms undergo selection, some characteristic may be carried along that wasn't selected. Even if some trait didn't provide an advantage, it could still be carries along as long as it isn't harmful. But a situation may arise in the future when that trait can become useful or harmful
Mutation is not the only source of genetic variation. Other mechanisms are genetic drift, gene flow, and symbiosis. Gene flow or migration is the movement of genes in a species from one population to another as the result of interbreeding.
The more non-resistant bacteria that are eliminated, the more opportunities for the resistant to reproduce and spread. Over time, the resistant bugs win the race, meaning the antibiotics become less and less effective
The more we use antibiotics, the faster resistance spreads. Any method we use to kill bugs will, unless it completely wipes out a species, cause a population of resistance bugs
What drives us?
Harm avoidance first. Our brain is equipped to register pain more sensitively than any other emotion. We also remember negatively arousing stimuli better. "It is the pain related signal that steers us away from impending trouble."
Our aversion to pain also encourages a human behavior: to take the most rewarding view of events. We interpret choices and events in ways that make us feel better. We often prefer to hear supporting reasons for our beliefs; think of ourselves as more talented than others, and make the best of bad situations
If certain neural connections help us interact with our environment, we use them more often than connections that don't help us. Since we use them more often, they become strengthened.
Does the brain work like a computer?
Computers record, and computers have things stored in specific places that are stable. Our brains do none of that. Even though we are capable of logic, our brain does not operate by the principles of logic. It operates by selection of pattern recognition. It's a dynamic network, not an "if-then" logic machine
If you're an expert, you have the abilities of grouping and exclusion — where you immediately get right down to the few possibilities that have a chance of success from the billions of possibilities that exist
Adaptive behavior for survival and reproduction
The hunter-gatherer environment has formed our basic nature
The individual comes first. There is no such thing as society. There are individual men and women, and there are families
All individuals have self-interest. We are interested in protecting ourselves and our close family
Altruism is not in our nature. But often, cooperation is in our best interest. Mutual aid has tremendous survival value
Repetition tests trust. Trust is key and fragile. It can vanish in a moment.
Communication encourages cooperation, we it may also be deceptive. People may bluff.
Long-term effective strategy is a modern version of tit-for-tat. We should cooperate at the first meeting, and then do whatever our opponent did the last time
When our opponent doesn't cooperate, we should retaliate. Then forgive and go back to cooperating the next round. This rewards past cooperation and punishes past defection
A tendency to fear: Our fears are always more numerous than our dangers
Fear is fundamental because life is fundamental. If we die, everything else becomes irrelevant
Failure to detect threats is often most costly than false alarms. Our ancestors learnt that in the long run, pain could be avoided if they were fearful. They survived dangers because they learned how to respond.
Fear warns us of potential harm and keeps us from acting in self-destructive ways. If helps us avoid threats and makes us act to prevent further damage. Fear guides us to avoid what didn't work in the past. Fear causes worry and anxiety, a normal response to physical danger
The more we are exposed to a stimulus, even a terrifying one, the higher our threshold of fear becomes
Seeking explanations
We don't like uncertainty or the unknown. We need to categorize, classify, organize, and structure the world. Categorizing ideas and objects helps us to recognize, differentiate and understand. It simplifies life.
The brain seems particularly attracted to new information and novel experiences. Recent studies suggest that the brain response to novelty
Our brain is wired to perceive before it thinks - to use emotions before reason. As a consequence of our tendency for fear, fast classifications come naturally.
Many anatomical and behavioral characteristics don't have any survival value, but play an important role in attracting mates. Strength and beauty are such signals
The Social Animal
We do not care about our reputation in towns where we are only passing through. But when we have to stay some time, we do care. How much time does it take? A time proportionate to our vain and paltry existence.
If we help another member in a small society, he many help us when we need it. If he doesn't, we may never help him again. This behavior is called reciprocation. A reputation for being reliable and trustworthy is important because how we acted in the past is the only guide to how we act in the future.
We have a strong concern for fairness. We get upset when thins are unfair. We sometimes even punish others at a cost to ourselves. Maybe we do't want to appear weak or easily taken advantage of. Since we evolved in small communities with repeated interactions, it made sense to build up a reputation for not appearing weak.
True reciprocity only works if (1) we live in the same small society so we recognize each other, can keep track of "services" given and received, and have future opportunities to interact, and (2) the cost of the act is pretty much the same as the future favor the recipient receives
Do good when others can see it. Reputation matters. We behave differently when we are watched or when our identities are made public
Traits like fear of failure, losing social status or reputation were important because they affected an individual's standing in the ancestral hunter-gatherer society
It is painful to lose status once it has been obtained
Buffett on why even smart people get bad results:
"It's ego. It's greed. It's envy. It's fear. It's mindless imitation of other people. If Charlie and I have any advantage, it's because we're rational and seldom let extraneous factors interfere with our thoughts ... We try to get fearful when others are greedy. We try to get greedy when others are fearful. We try to avoid any kind of imitation of other people's behavior ... IQ is the horsepower of a motor, but the efficiency with which a motor works depends on rationality"
Part 2: The Psychology of Misjudgements
There are 28 kinds of misjudgements
1. Bias from mere association: automatically connecting a stimulus with pain or pleasure, including liking or disliking something associated with something bad or good. Includes seeing situations as identical because they seem similar.
(Pavlovian Effect)
We can learn to fear a harmless stimulus if it is paired with an unpleasant one, and vice versa
2. Underestimating the power of rewards and punishment
You get what you reward for. If you want ants to come, you put sugar on the floor
One a behavior becomes learned, variable rewards strengthen the behavior. Behavior that is rewarded on an unpredictabe basis has the highest rate of response and is the most difficult to extinguish. This is how gamblers are rewarded. Moreover, the greater the reward, the more resistant the behavior is to extinction
Frequent rewards feel better. It feels better to gain $50 twice than gain $100 once. Similarly, it feels better to lose $100 once than lose $50 twice
After a success, we become overly optimistic risk-takers. After a failure, we become overly pessimistic and risk-averse — even in cases where success or failure was merely a result of chance
Mark Twain: "We should be careful to get out of an experience only the wisdom in it and stop there. We don't want to be the cat that sits down on a hot stove-lid. She will not sit down on a hot stove-lid again — but she will also not sit down on a cold one anymore"
Praise is more effective in changing behavior than punishment.
Warren Buffett: "Goals should be (1) tailored to the economics of the specific operating business, (2) simple in character so they can be easily measured, and (3) directly related to the daily activities of the plan participants"
Be careful when designing systems. They can be hard to change. "It's very hard to change a system when the guy whose hand is on the switch benefits enormously from that system"
3. Underestimating bias from own self-interest and incentives
Incentive from the decision maker determine behavior. Never ask the village barber if you need a haircut
Don't trust projections. They create an illusion of apparent precision. Look at track records instead.
Plato: "Do not train boys to learning by force and harshness, but lead them by what amuses them, so that they may better discover the bent of their minds"
4. Self-serving bias - overly positive view of our abilities and future. Includes over-optimism
"Things that happen to others don't happen to me". We see ourselves as unique and special and have an optimistic view of ourselves
We tend to over-estimate our abilities and future prospects when we are knowledgeable on a subject, feel in control, or after we've been successful
In a bull market, once must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world.
Recognize your limits — how well do you know what you don't know?
5. Self-deception and denial - distortion of reality to reduce pain or increase pleasure. Includes wishful thinking
Richard Feynman: "The first principle is that you must not fool yourself — and you are the easiest person to fool"
6. Bias from consistency tendency (Sun Cost Fallacy) - being consistent with our prior commitments and ideas even when acting against our best interest or in the face of disconfirming evidence. Includes confirmation bias - looking for evidence that confirms our actions and beliefs and ignoring or distorting disconfirming evidence
Don't make snap judgements, since it's hard to overcome the anchoring bias that comes from this
Buffett: "We don't have a strategic plan. Thus we feel no need to proceed in an ordained direction, and can simply decide what makes sense for our owners"
Charles Munger: "The task of man is not to see what lies dimly in the distance, but to do what lies clearly at hand. Obviously, you look ahead as far as you can. But that's not very far."
How to people seduce us? They make us first agree to a small request. This way they create a commitment. Then they make a second and larger request. We are then more likely to comply because we want to appear consistent.
Heavy ideology is one of the most extreme distorters of human cognition. Stay away from it
You can't avoid wrong decisions. But you can recognize them promptly and do something about them
7. Bias from deprival syndrome (Loss aversion) - strongly reacting when something we like and have (or almost have) is taken away or lost. Includes desiring and valuing more what we can't have or what is (or threatens to be) less available
A lost opportunity of making $100 has the same value as a realized loss of $100
A very important principles of investing is that you don't have to make it back the way you lost it. That's usually a mistake.
What you paid for your house, stock, or car has no relevance to its value
8. Status quo bias and do-nothing syndrome - keeping things the way they are. Includes minimizing effort and a preference for default options
Buffett's Noah principle: "Predicting rain doesn't count; building arks does."
9. Impatience - valuing the present more highly than the future
10. Bias from envy and jealousy
Envy is one of the fundamental causes of human suffering
11. Distortion by contrast comparison - judging and perceiving the absolute magnitude of something not by itself but based only on its difference to something else presented closely in time or space or to some earlier adaptation level. Also underestimating the consequences over time of gradual changes (frog in boiling water syndrome)
The difference between $100 and $110 and $2850 and $2860 is the same
Evaluate people and securities by themselves, and not by their contrast
12. Bias from anchoring - overweighing certain initial information as a reference point for future decisions
13. Over-influence by vivid or the most recent information
The more dramatic, salient, personal, entertaining, or emotional some information/event is, the more influenced we are
14. Omission and abstract blindness - only seeing stimuli we encounter or that grabs our attention, and neglecting important missing information or the abstract. Includes inattentional blindness.
We react more strongly to the concrete and specific than to the abstract. We overweight person experiences over vicarious ones
Today 14 million people didn't win the lottery. We see the kind of risk that makes headlines. We don't see the statistical risk
We see available information. We don't see what's not reported
15. Bias from reciprocation tendency - repaying in kind what others have done for us like favors, concessions, information, and attitudes
A gift with our name on it is hard not to reciprocate
People don't want to feel indebted. We are disliked if we don't allow peope to give back what we've given them
A favor or a gift is most effective when it is personal, significant, and unexpected
16. Bias from over-influence by liking tendency - believing, trusting and agreeing with people we know and like. Includes bias from over-desire for liking/social acceptance and for avoiding social disapproval. Also bias from disliking — our tendency to avoid and disagree with people we won't like
Talk to a man about himself and he will listen for hours
We have a strong desire for avoiding social disapproval, exclusion, humiliation, public shame, and losing status. This contributes to conformity
17. Bias from over-influence by social proof. Includes crowd folly.
Most managers have very little incentive to make the intelligent-but-with-some-chance-of-looking-like-an-idiot decision. Their personal gain/loss ration is all too obvious: if an unconventional decision works out well, they get a pat on the back. If it works out poorly, they get a pink slip.
Nietzsche: "Madness is a rare thing in individuals - but in groups, parties, peoples, and ages it is the rule"
Groups don't encourage differences in opinion
18. Bias from over-influence by authority — trusting and obeying a perceived authority or expert
19. Sensemaking — constructing explanations that fit an outcome. Includes being too quick in drawing conclusions. Also thinking events that have happened were more predictable than they were
20. Reason respecting — complying with requests merely because we've been given a reason. Includes underestimating the power in giving people reasons
Exception: You can't reason a person out of position he did not reason himself into in the first place. Sometimes, it is better to appeal to emotions that to reason since people are more moved by what they feel than by what they understand
21. Believing first and doubting later — believing what is not true, especially when distracted
We first believe all information we understand and only afterwards with effort do we evaluate, and if necessary, un-believe it
22. Memory limitations — remembering selectively and wrong. Includes influence by suggestions
23. Do something syndrome — acting without a sensible reason
We sometimes act because we can't sit still. Many CEOs attain their positions in part because they have an abundance of animal spirits and ego. When such a CEO is encouraged by his advisors to make deals, he responds like a teenager who is encouraged by his father to have a normal sex life. It's not a push he needs"
"It is not enough to be busy; so are the ants. What are we busy about?" Don't confuse activity with results. There's no use running if you're on the wrong road
24. Say-something syndrome — feeling a need to say something when we have nothing to say
Syrus: "I have often regretted by speech, never my silence"
25. Emotional arousal — making hasty judgements under the influence of intense emotions
When we have just gone through an emotional experience, we should hold off on important decisions
26. Mental confusion from stress
The less control we perceive we have over our lives, the easier we fall victim to stress. The more stress we experience, the more we tend to make decisions that are short-term. Stress also increases our suggestibility
27. Mental confusion from physical or psychological pain, the influence of chemicals, or diseases
28. Bias from over-influence by the combined effect of many psychological tendencies operating together
You can learn to make fewer mistakes than other people, and to fix them faster when you do make them
Use a two-track analysis: 1) what are the factors that really govern the interests involved for all parties, rationally considered? 2) what are the subconscious influences?
Take all the main models from psychology and use them as a checklist in reviewing outcomes in complex systems
Part 3: The Physics and Mathematics of Misjudgements
1. Systems Thinking
Consider secondary and higher order consequences, including the likely reactions of others. Also consider the fact that your estimations are imprecise, and that you should not be too confident in them. Some things are possible to predict short-term but impossible to predict long-term
Try to optimize the whole system instead of its individual parts
2. Scale and limits
Changes in size or time influence form, function, and behavior. Large objects have a lot of momentum and are hard to change. Economies and diseconomies of scale
Consider breakpoints, critical thresholds or limits. There can be a straw that breaks the camel's back
Consider constraints - the bottleneck's performance
Small, slow changes over long periods of time can have great consequences
3. Causes
Randomness always influences good and bad outcomes
Don't mistake correlation for cause
Don't attribute to a single cause when there are multiple causes
"We identify the wrong cause because it seems the obvious one based on a single observed effect. As Bertrand Russell says: Obviousness is the enemy to correctness"
4. Numbers and their meaning
Don't underestimate the effect of exponential growth
Don't underestimate the time value of money
5. Probabilities and number of possible outcomes
Don't underestimate risk exposure in situations where relative frequency and/or magnitude of consequences is unknown or changing over time
Don't underestimate chances of rare/extreme events
Don't overestimate the chances of widely publicized and highly emotional events
Always consider the consequences of being wrong. Know your worst case
Optimize for the expected value (in a mathematical sense), which avoiding risk of ruin
Never something you have and need for something you don't need
6. Scenarios and Horizons
Time horizon changes probabilities. Always add a factor of safety for known and unknown risks
In a project, each individual step has some probability of failure. If one key component fails, the system may fail. Add a factor of safety for known and unknown risks
7. Coincidences and miracles
Surprises and improbable events happen if they have enough opportunities to happen
8. Reliability of case evidence
Don't overweigh individual case evidence. Instead, consider evidence from many similar cases. Don't give in to survivorship bias
9. Misrepresentative evidence
Conditions, environments, and circumstances change
Ask: "Why was past experience the way it was? What reason is there to suppose that the future will resemble the past? Has the environment changed? Are the conditions similar? Are the context and circumstances that caused the past still present?"
10. Post-mortems
Ask:
- What was my original reason for doing something? What did I known and what were my assumptions? What were my alternatives at the time?
- How did reality work out relative to my original guess? What worked and what didn't?
- Given the information that was available, should I have been able to predict hat was going to happen?
- What worked well? What should I do differently? What did I fail to do? What did I miss? What must I learn? What must I stop doing?
Part 4: Guidelines to better thinking
1. Models of reality
Master multiple mental models which underlie reality. Models based on the hard sciences and engineering and the most reliable
A model should be easy to use. If it's complicated, we don't use it
Have multiple models. If you only have a few, you'll use a hammer for all problems instead of the whole toolbox
2. Meaning
Know what everything means:
- meaning of words
- meaning of an event
- causes
- implications
- purpose
- reason
- usefulness
Niels Bohr: "Never express yourself more clearly than you are able to think"
3. Simplification
Simplify your decision making process. Use checklists. Only make a few high quality decisions every year.
Be problem-oriented, not method-oriented. Use whatever works. Look for good enough solutions appropriate to the problem at hand, not perfection and beauty
Make fewer and better decisions. Dealing with what's important forces you to prioritize. There are often just a few actions that produce most of what we are trying to achieve. There are only a few decisions of real importance.
Know what to avoid — bad people, bad businesses, bad regulatory environments.
4. Rules and filters
Make "what do do" and "what to avoid" rules. Use as few criteria as possible to make your decisions.
Eliminate everything you can. It'll be a great conservator of effort.
5. Goals
When you don't know what harbor you are heading for, no wind is the right wind
Goals should be:
- clearly defined
- focused on results
- realistic and logical — what can and can't be achieved?
- measurable
- tailored to our individual needs
- subject to change
6. Alternatives
Consider opportunity costs
7. Consequences
Consider secondary and long-term effects of an action
1) Pay attention to the whole system. Direct and indirect effects
2) Consequences have implications, some which may be unwanted. We can't estimate all possible consequences but there is atleast one unwanted consequence we should look out for
3) Consider the effects of feedback, time, scale, repetition, critical thresholds, and limits
4) Different alternatives have different consequences in terms of costs and benefits. Estimate net effects over time and how desirable these are compared to what we want to achieve
8. Quantification
It's better to be roughly right than precisely wrong. Don't overweigh what can be counted and underweigh what cannot. Beware of false concreteness
Return on beginning equity capital is the most appropriate measure of singe-year managerial performance
9. Evidence
What experiment can I do to figure this out? Strive for objectivity
Occam's Razor: The explanation based on the least number of unproven assumptions is preferable, until more evidence comes along
Falsify and Disprove
10. Backward Thinking
Start from what an undesirable consequence would be. Then work backward to avoid it
11. Risk
Always ask what the potential downside is, and avoid risk of ruin
"A life without adventure is likely to be unsatisfying, but a life in which adventure is allowed to take whatever form it will is sure to be short"
A single, big mistake can wipe out a long string of successes. Avoid serious risks. Never underestimate the chance of rare events
12. Attitudes
Stick within your circle of competence. You would rather deal with what you understand. Play competitive games in fields where you have a clear advantage
Ask: what is my nature? what motivates me? what is my tolerance for pain and risk? what has given me happiness and unhappiness in the past what things and people am I comfortable with? what are my talents and skills? Do I know the difference between what I want and what I'm good at? Where do I have an edge over others? What are my limitations?