Guest Post: A Short Lesson In Bad Decision-Making

Tyler Durden's picture




 

Submitted by Adam Taggart of Peak Prosperity

A Short Lesson in Bad Decision-Making

In business school I had to take an introductory class in statistics that we colloquially called "D&D." The official course name was Data & Decision-making.

In retrospect, it was a truly valuable class (one of very few I encountered in b-school). If you can figure out how to use statistics to determine the most probable outcome from a set of scenarios, or find predictive correlations from within a sea of data, that's real power. You can take a lot of the guesswork out of decision-making and consequently make the "right" call much more often.

I performed miserably in this class. But I had a lot of company; it was perennially voted the hardest in the school's core curriculum.

While I sometimes fantasize (masochistically) about taking the class again to master the black magic of statistics, I realize that I did learn a valuable lesson: Humans are innately poor at estimating probability.

This was proved to me time and again throughout that course, starting on the very first day.

A gifted young professor taught D&D. I was 27 at the time, and he was only a year or two older than I. Wicked smart guy.

Given his age, he had a few things to prove to us on that first day of class. He wanted to demonstrate he was a little more fun and hip than the stuffy older profs who taught our other courses. He also intended to show that even though he was the same age as us, his was the Alpha cerebrum in the room.

So as we took our seats for the first time, he asked: "Who wants to bet me $5 that two folks in this room have the same birthday?"

We all looked at each other. There were about 65 students, plus the prof. We were all thinking: "365 days in a year. Only 66 people. Those odds don't seem so bad..."

A hand went up, taking the bet. The prof asked the folks in the back row to start shouting out what their birthday was, one at a time. We got about 6 people in before someone in the middle of the room said, "That's my birthday, too." A $5 bill was passed up to the teacher.

"Anyone willing to bet me again?" he asked.

Another hand went up, figuring the odds just got much better as the "fluke" overlap had been removed.

The exercise repeated. It only took a few more shoutouts to hit another shared birthday. Another $5 was handed over.

"Anyone else?" said the professor.

Another brave student made the bet and lost his $5.

"Again?"

This time we students were much more tentative. But after a while I shot my hand up. "What the heck," I figured. "He's got to be running out of luck."

Wrong. I lost my $5 in about ten seconds.

What I later learned was that the professor was making an exceptionally safe bet that only appeared risky because we students were grossly misjudging his probability of being wrong.

In fact, as long as there were 57 students left, the prof's chances of winning the bet were over 99%(!). The odds would continue to be overwhelmingly in his favor all the way down to 23 people, at which point they would be 50/50.

It turns out this is a classic probability exercise known as The Birthday Problem. And it apparently has kept the beer funds of statistics professors well-capitalized for ages. 

The lesson I took from the experience is this: Probability estimation is non-intuitive. If you need to make an important decision about the odds of something occurring, don't go with your gut. It will be often wrong (sometimes wildly so). Get data, crunch the numbers, and consult a professional if you can't figure things out on your own.

This caution with regard to decision-making has served me well over my career. I've lost count of the number of times I began with a strongly-felt guesstimate that was torn to shreds by the time I did the math and learned how far reality was from my gut instinct.

And what worries me – scares me, is more accurate – is that I don't observe this same caution in the actions of the people making the truly big decisions. Like the Fed, Congress, and many of our state governors. Instead, I see people – many of whom don't have strong empirical skills or practical business experience – making rash decisions about debt, deficits, taxes, money supply, interest rates, pensions, etc. that will have implications on a staggering order of magnitude. I myself can't wrap my brain fully around some of these (classic example: The Crash Course Chapter 11: How Much Is a Trillion?). And even though I'm by no means the smartest guy in the room, I have little confidence that a career politician is able to comprehend these gargantuan repercussions at a materially higher level than I can. 

Sure, it's easy if you're an elected official to simply print more money. Or run trillion-dollar deficits. Or raise taxes instead of cutting spending. Or mint the coin. Or burn more oil. But these are not short-lived decisions. Their implications will manifest over generations.

And as the system becomes more unstable, the gut decisions will come faster and more furiously, made by those with the most hubris.

Which is why we continue to recommend taking action at the individual level, to reduce your vulnerability as much as possible in advance:

  • Find yourself a trustworthy financial adviser who will invest your paper capital with these risks in mind (we endorse several).
  • Own some gold and silver as insurance against a currency crisis.
  • Diversify
    into other hard assets if you're able to, particularly those with
    potential to produce primary wealth (timber, livestock,
    vegetables/grain, minerals, energy, etc.).
  • Assess
    your employment situation – how vulnerable is your income? Invest in
    ways to make yourself more valuable to your employer, add additional
    source(s) of income, and/or create your own business. 
  • Invest in increasing your personal resiliency (homestead investments, skill-building, physical & emotional health, and community)

If only it were $5 of beer money that was on the line, instead of our global standard of living...

0
Your rating: None
 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Sat, 01/12/2013 - 14:17 | 3147226 Flakmeister
Flakmeister's picture

People thinking with their gut, i.e. guided by ideology, is a reflection of the lack of proper science training....

And look at the fucking mess it has created....

Sat, 01/12/2013 - 14:42 | 3147284 Uber Vandal
Uber Vandal's picture

My gut instinct has been much more accurate than when I look at something "logically".

For example, my gut instinct may tell me "prepare for coming storm", but logically, it is warm and sunny outside, without a cloud in the sky, what is there to worry about??

Sat, 01/12/2013 - 14:45 | 3147288 Flakmeister
Flakmeister's picture

Beg pardon?? I think you are carrying your analogies a bit too far...In other words, a perfect example of what the article is about...

Sat, 01/12/2013 - 15:32 | 3147371 Uber Vandal
Uber Vandal's picture

Ok, how about this...

There were about 65 students, plus the prof. We were all thinking: "365 days in a year. Only 66 people. Those odds don't seem so bad..."

Then your gut intinct speaks up, if you are listening/paying attention, and the warning alert should be: Why is the professor making the bet, unless he may have an advantage, or know something I do not.

https://en.wikipedia.org/wiki/Birthday_problem

 

Sat, 01/12/2013 - 15:55 | 3147406 Flakmeister
Flakmeister's picture

I think you may have fucked up the cut and paste somewhere...

I am quite familiar with the birthday problem, however, the gamblers fallacy is the simplest example of the lack of understanding probability...

Math and probability can be a very subtle taskmaster...

And as far as the real physical world goes, Relativity and Quantum Mechanics are like a jack-booted kick into that "gut instinct"...

Sat, 01/12/2013 - 17:59 | 3147586 AgAu_man
AgAu_man's picture

Trust is efficient but unreliable, and MUST be earned, over time.
Proceed on Principle, I.e. VERIFY.

Sat, 01/12/2013 - 18:21 | 3147622 macholatte
macholatte's picture

 

And what worries me – scares me, is more accurate – is that I don't observe this same caution in the actions of the people making the truly big decisions. Like the Fed, Congress, and many of our state governors. Instead, I see people – many of whom don't have strong empirical skills or practical business experience – making rash decisions about debt, deficits, taxes, money supply, interest rates, pensions, etc. that will have implications on a staggering order of magnitude.

 

The issue at hand regarding the "decision makers" is not probability or their level of education or "real world" experience or any of that. The issue is motivation. They are motivated by self interest at all times. Factor that into the equation and the mosaic comes into focus.

Zero accountability & zero personal risk - what does that do for your statistics?

 

Sun, 01/13/2013 - 10:49 | 3148630 disabledvet
disabledvet's picture

Is fear rational? It is based on something "in the future." so why do we feel it anyways "if it's just a numbers game"? The fact of the matter is Wall Street is CONSUMED by fear. ALWAYS. No matter how "greedy" they purport to see themselves it is what they FEAR that guides their decision making. Hence "they biggest risk is the one they will never take." yet we know there is no greater fact in life than the act of living is risky...and so most if not the bulk of humanity is relegated to the world of "snore." while this is not a bad life (my favorite actually) it is not the "life of money." Money must be risked to be rewarded...failure is inevitable, emotional loss and the destruction of self the norm. The best that can be said is "the LESS real we make it the better." the current iteration of Cookie Cutter seems bent on seeing their own destruction...on time and under budget. Some technological terror...people won't even be able to look each other in the eye just to say hello. BLINDED by fear in the information age. Of course "that was the plan all along" wasn't it? To terrify the general population so much they couldn't even shit themselves? Forget the banks...it's a miracle we even have a country right now.

Sun, 01/13/2013 - 14:31 | 3149034 MeelionDollerBogus
MeelionDollerBogus's picture

Wall street is run by machines now. All amounts of trading - what, when, how much, how quickly, how much margin is safe to use - is decided by machines, 2000 times per second or faster. These machines have no fear & that's how you get flash crashes - the obvious end-result of collapse is avoided by humans who have a self-interest in avoiding it. Fear.

Now market regulators are working even harder to get fear out fo the market - if NASDAQ doesn't like a trade it will reverse it without possibility for appeal, even if you made money it. They'll reverse it, saving the loss from another, reducing that party's fear.

 

Sat, 01/12/2013 - 16:59 | 3147504 adr
adr's picture

I hated the stupid birthday bet. It isn't statistics, its bullshit. It really has nothing to do with your gut, but the power of wanting to kiss authority's ass. The professor knows someone will take him up on the bet because of the pressure to do so. Even if you believe yourself to be right, when put into a peer pressure scenario you will question that belief especially if the one asking the question is the authority figure.

When the professor asked me to take the bet on day one I responded with a no. He aksed why, I said that the probability of two people in the room having a same birthday is very high. We had 75 students in my class. There are a few times a year when there are statistically more babies born. October and November for example, nine months from the start of Spring. May is also very popular since nine months prior to then is when people start spending more time indoors. So even without calculating exact odds, I know there is almost a 100% chance at least two people will share the same birthday.

To be an ass I said to him, "How about I bet you $10 that nobody else has the same birthday as me." He didn't take the bet knowing the odds just swung wildly in my favor.

Statistics and charts are just bullshit people use to try and prove their gut wasn't right all along. You can pull out 100 charts to "prove" the market is undervalued, but any right minded person knows in their gut that CNBC is full of shit.

Instinct is there for a reason. Its too bad most of the people have chosen to ignore it.

Sat, 01/12/2013 - 18:55 | 3147669 Flakmeister
Flakmeister's picture

It is clear that you fear things that you don't understand. I'm sorry that you appear to understand so little... The Taliban works on gut instinct as well as do most primitive cultures governed by superstitition...

Sat, 01/12/2013 - 22:26 | 3148007 Ident 7777 economy
Ident 7777 economy's picture

 

One word, a former stock ticker symbol: LTCM

Sun, 01/13/2013 - 10:59 | 3148645 disabledvet
disabledvet's picture

"I know something you don't" ain't the same as "you don't know jack." their are "tricks to the trade" and "being smarter" ain't one of them. "Insider trading" is illegal for a reason. "it makes money." enough to buy regulators? Ha! "and then some!" you can buy whole countries and run them "on inside information." but do they really "know" something we don't? Or are they playing on mankind's inherent fear of "not being known" or "appearing to be a total idiot"? The question that should be asked is not "why do I APPEAR so stupid" but "how did I not know that given all that is knowable now?" (sent to you via my I-phone...

Sat, 01/12/2013 - 20:22 | 3147829 taniquetil
taniquetil's picture

"There are a few times a year when there are statistically more babies born."

 

But statistically that's not the reason why he has the probability of winning. The actual reason that he is demonstrating has to do with how you cound pairs of observations.

 

The reaosn the professor one is not that your sample size is only 75 kids in the room. It's 75 kids in the room, each paired against every other kid in the room.

 

Or, to put it in a purely mathematical sense, the Birthday Problem was once used as a cryptographic attack, and it wasn't because certain prime numbers happen more than once.

Sat, 01/12/2013 - 14:15 | 3147233 Snakeeyes
Snakeeyes's picture

With the media and pundits like Mark "Zaney" Zandi spewing "Buy homes! Buy homes!" and we wonder why there is gut reaction. All they hear is propaganda.

http://confoundedinterest.wordpress.com/2013/01/11/more-housing-angst-us...

Sat, 01/12/2013 - 16:20 | 3147437 formadesika3
formadesika3's picture

I wish I'd had his stats teacher. Dumb-ass who taught me couldn't figure out how I was gaming his grading system even after I explained it to him. So he sat me down in the front row for the final exam (25% of total grade) 'cause he just knew I was cheating somehow and I still got an A- on the course.

Which kind of pisses me off because I DIDN'T LEARN NOTHIN'.

Sun, 01/13/2013 - 15:17 | 3149133 Never One Roach
Never One Roach's picture

But "house prices never go down," right?

Sat, 01/12/2013 - 14:17 | 3147240 tooriskytoinvest
tooriskytoinvest's picture

Prepare For Worst: World War 3, Risk of Recession, Stagnation in 2013, Worst Flu Seasons In A Decade, A Century Of Drought, And American Finance Is Going To Be In A (relative) Decline For The Next 2 or 3 Decades...

http://investmentwatchblog.com/prepare-for-worst-world-war-3-risk-of-rec...

Sat, 01/12/2013 - 14:20 | 3147244 TraderTimm
TraderTimm's picture

1.) Only keep enough working capital in the conventional financial system for monthly flows. (Reduce this number to the absolute minimum, assume anything parked here will eventually become inaccessible or worthless.)

2.) Everything else gets converted to the wealth-preservation vehicle of your choice, with a small fraction in available currency. (With the intent that if that small wad of bills becomes worthless, it won't hurt you - for emergency use before the system completely goes insane.)

3.) Any communications from a bank, credit card company, trading firm, fund manager, or any other entity who has a vested interest in the system continuing just as it is -- should be assumed to be outright falsehoods and manipulations.

4.) Build self-sufficiency and improve your network of friends, neighbors and like-minded people you can count on in a tough situation.

5.) All news reports coming from large corporate sponsored interests are agenda-laced fabrications. Invert any intended meaning when faced with stories about how "Everything is fine" and "there will be no devaluation". (Insert cases as needed.)

Sat, 01/12/2013 - 20:35 | 3147846 prains
prains's picture

6) Guns, Gas, Gold, KY

Sat, 01/12/2013 - 14:39 | 3147276 Flakmeister
Flakmeister's picture

And still people think that we can pull off nukes...

From Undertow over at TOD:

------------------------------

Re: A Nuclear Post-Mortem for Sandy

The (Oyster Creek) reactor was shut down for refueling at the time the hurricane hit, and refueling operations were suspended in preparation for the storm’s arrival. That turned out to be prudent because of the loss of grid power that occurred with the hurricane’s arrival.

The loss interrupted cooling of the reactor and the spent fuel pool. With no operator action, that would eventually have been a problem; the commission’s report said that without cooling, the spent fuel pool would have boiled in 28 hours. Some hours after that, enough water would boil away to create the possibility of fuel damage, meaning a release of radioactive material. But it had no immediate impact because operators re-established cooling after 85 minutes.

They really were exceptionally lucky they had just shut down for routine refueling before the hurricane hit.

The operators kept control room logs in a way that safety inspectors found hard to decipher

Best not "DECIPHER" them for the public. Reading the report it appears that the water level had risen beyond the pre-set red safety limit where the main intake pumps had to be shutdown. After communication with the OCC (Outage Command Center) the "limit" was raised and the pumps ordered to continue running. All electronic monitoring of the water levels at the intakes had failed and personnel could no longer take reliable manual measurements as required due to the flooding and high winds.

Wouldn't have been pleasant working in the plant that night I'm sure. And if they had actually been online at the time and/or the water risen even higher...

Sat, 01/12/2013 - 18:09 | 3147602 rehypothecator
rehypothecator's picture

"They really were exceptionally lucky they had just shut down for routine refueling before the hurricane hit."  

 

Why would luck have anything to do with it?  It was known for a week or two that the hurricane was going to hit, before it hit.  They were only lucky if it takes longer than a week to shut a nuclear power plant down.  

Sat, 01/12/2013 - 18:59 | 3147675 Flakmeister
Flakmeister's picture

Why don;t you review what NHC was saying about Sandy a week beforehand... It was the Europeans that predicted a Tri-state hit when Sandy was south of Cuba...Eventually the inferior NHC simulations agreed, 2-3 days out... It is all about computing power and peta-flops....

Sat, 01/12/2013 - 22:33 | 3148018 Ident 7777 economy
Ident 7777 economy's picture

 

 

You missed the point; plant operations personnel have long ago begun to ignore the NHC (and NOAA) and pay attention to the Euro model which is proving to be MUCH more accurate for wx prediction.

 

You're not into meteorology, are you?

Sat, 01/12/2013 - 21:18 | 3147916 BooMushroom
BooMushroom's picture

 

That turned out to be prudent because of the loss of grid power that occurred with the hurricane’s arrival.

The loss interrupted cooling of the reactor and the spent fuel pool.

Odd, isn't it? That the problem is always that the power plant doesn't have power? Would it have been a problem if it had been left running, and could power its own pumps and cooling mechanisms?

Sat, 01/12/2013 - 22:36 | 3148023 Ident 7777 economy
Ident 7777 economy's picture

 

"Would it have been a problem if it had been left running, and could power its own pumps and cooling mechanisms?

 

Where does all that excess energy go? It's not like you throttle these nuke plants back to .01% output for on-site use only ...

 


Sat, 01/12/2013 - 14:51 | 3147296 koncaswatch
koncaswatch's picture

The awesomeness of a trillion in seconds:

1 billion seconds = 32 years

1 trillion seconds = 31,710 years

Most "gut feelings" can't grasp that relationship.

Sat, 01/12/2013 - 14:56 | 3147303 Flakmeister
Flakmeister's picture

Yep...

A fair number of people can grasp a million, now try a million million..

Sat, 01/12/2013 - 16:26 | 3147443 Winston Churchill
Winston Churchill's picture

Exactly.

I can pay the USs debt dramatically at one stroke.

Revert to the original English definitions.One billion = a million million.

One trillion = a billion billion.It will sound so much better,and those

trillion dollar coins will allow them to pay the debt off,build the Death Star,

and have money left over.A krugman wet dream.

Sat, 01/12/2013 - 15:11 | 3147335 Skateboarder
Skateboarder's picture

Extending your shit... the following calculation is for someone who can process shit decently fast. Apologies for not spelling out cardinal numbers (an aesthetic rule long forgotten by most), but numeric representation is more vivid in this case.

I say you can reliably count 2 notes (power of 10 denominations) a second. That's 5 seconds to count 10 notes. Add 5 more seconds to add the completed 10* figure to the outstanding sum (* being a 'regular expression' character indicating that zero or more of the preceding character, 0 in this case, may replace the asterisk. So 100, 1000, 10000, 100000000000, etc. are valid matches for 10*).

Taking $1,000 (10^3) notes, you can can count $10,000 (10^5) and add to the current sum in ten seconds. A trillion dollars (10^12) would then take you 10^12  /  10^5  * 10 seconds = 10^8 seconds.

10^8 seconds * (1min / 60 seconds) * (1 hour / 60 minutes) * (1 day / 24 hours) * (1 year / 365 days) = 3.17 years = 3 years and 62.4 days.

FUCK THAT!

Sat, 01/12/2013 - 15:32 | 3147369 koncaswatch
koncaswatch's picture

I cheated; set up an MSexcel scenario and let the CPU do the work. <as he hangs his head in shame>

Sat, 01/12/2013 - 15:45 | 3147394 Skateboarder
Skateboarder's picture

That's okay bud, I had to use a calculator for the final step too. Someday I will master one of the speed systems of computation and be able to do it all in my noggin.

Sun, 01/13/2013 - 11:06 | 3148653 disabledvet
disabledvet's picture

"I could become the first trillionaire" too...game over folks, guess who won.

Sat, 01/12/2013 - 14:56 | 3147302 q99x2
q99x2's picture

Humans are innately poor at estimating probability.

when fraud is rampant in the system.

Fella you better start stockpiling food and water, gold and silver, Smith and Wesson otherwise you're going be bankster food with that stuff you've been touting about.

Sat, 01/12/2013 - 15:01 | 3147312 Flakmeister
Flakmeister's picture

Did you get that  application to  The Citadel in yet?

Sat, 01/12/2013 - 22:37 | 3148027 Ident 7777 economy
Ident 7777 economy's picture

 

Funny ... you read Drudge too ...

Sat, 01/12/2013 - 15:04 | 3147308 rtalcott
rtalcott's picture

Probability Distribution?  wtf is that?  Error? What error this is EXACT!  We know what we are doing!

How can we get any other result?  It's NOT POSSIBLE!  This HAS TO WORK!

 

Most decisions are very poorly thought out...and it seems the more significant the decision the more it's faith based...at least if it's a government decision.

 

Probability estimation IS INTUITIVE IF YOU UNDERSTAND THE SYSTEM!  If you don't take the time to understand the system you are guessing...

Sat, 01/12/2013 - 15:04 | 3147316 chistletoe
chistletoe's picture

Your premise is that the celebrated man on the street cannot make a reasonable guess, about a particular risk, but an expert can.

 

I think anybody who reads zero hedge regularly would take strong issue with that premis.

 

Just for example, the "experts" at numerous insurance companies have been telling me that $1500 is a reasonable bet that my house will burn down within 365 days and I will incur loss.  My gut told me otherwise.  So I did some rexsearch, and found that approximately $1430 of that amount supports the employees, buildings, stockholders, executives, advertising, mass-mailings, etc of the insurance company and the other $70 is a reasonable bet because the statistical odds of my house buring down in a particular year is only 1/2000 ....

 

What my approachis is to read, think, and calcualte probabilities all of the time, just for practice.  Zero Hedge has made the point over and over and obver again that the tail risk, that is to say the risk of total financial system breakdown, is grossly underestimated by ALL the "experts" because some are lying and others are just lying to themselves.

 

The independent man, with half a brain, who uses it for something more deliberate than a sponge absorbing and consuming the crap that this society constantly pushes on him, if he constantly seeks out alternative information sources and makes critical judgements on his own, can make much better snap judgements than any "expert".

Sat, 01/12/2013 - 16:35 | 3147321 rtalcott
rtalcott's picture

What needs to be defined is exactly what is an "expert."  Then you need to find one without BIAS...good 'effing luck,

Sat, 01/12/2013 - 16:35 | 3147456 Winston Churchill
Winston Churchill's picture

A Drip under presure works for me.

Sat, 01/12/2013 - 15:45 | 3147385 rwe2late
rwe2late's picture

It's not just

the odds of YOUR house burning done and the insurer's largesse,

you also must help subsidize the owners of the multi-million dollar

profitably maldeveloped beachfront and forested homes that might be burned or washed away,

as well as the developers and owners of poorly constructed slum tenements, strip malls, and tract housing.  

Nor should we forget the "Prohibition II" surcharge (burglary/property losses due to the crime-generating "war on drugs").

Sat, 01/12/2013 - 18:10 | 3147604 Umh
Umh's picture

Do they cover damage done by the police when they descend on your place in response to an anonymous tip?

Sun, 01/13/2013 - 00:18 | 3148226 Mike in GA
Mike in GA's picture

Isn't that 'self-insured' by the taxpayers, ie the municipality?

Mon, 01/14/2013 - 18:22 | 3152307 e-recep
e-recep's picture

plus the expenses of running such an operation. but wait, after adding all in we end up at us$ 1500 once again. they do it for a profit after all, why else would anyone provide such services.

those companies are not run by idiots and most of them have serious competition. somethings are easier said than done.

Sat, 01/12/2013 - 15:32 | 3147374 rlouis
rlouis's picture

Dumbing down the educational system does work to keep the elite on top, but kills the empire.  Hubris indeed.

Sat, 01/12/2013 - 15:33 | 3147377 TrustWho
TrustWho's picture

I am completely confident in our political discourse and decision making. Watch my proof....

http://www.youtube.com/watch?v=dzOey0l6OPU

 

Sat, 01/12/2013 - 15:45 | 3147384 ToNYC
ToNYC's picture

don't go with your gut

 

If you feed your gut second-hand information and are approved by agenda-defendas while digesting charts with carefully chosen units of time and value so staging those agendas; I'd toss the ball into the stands and find another field to graze on my success. Then you can massage your innards with a soft bag of warm water while I enjoy fading your team. Cognitive dissonance must be a threat and a call for "more BIG data" rather than an eye-opener for the ages and a pardigm re-arranger.


Sat, 01/12/2013 - 15:41 | 3147388 rwe2late
rwe2late's picture

But, but
what about "love"?

Should we assume listening to the "heart"

is different than going with the "gut" ?

Sat, 01/12/2013 - 16:13 | 3147433 Skateboarder
Skateboarder's picture

The heart is a utilitarian machine - it works to increase marginal utility for everything. The gut, in comparison, is a greedy fuck. I'd go with the heart always.

Do NOT follow this link or you will be banned from the site!