YOU’RE MAKING BAD DECISIONS ALL THE TIME

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No I am not trying to depress you, or claim

superiority… I am making

bad decisions, too.

You see, I have just read

Daniel Kahneman’s book,

“Thinking, Fast and

Slow.” For those who are

not familiar with Daniel Kahneman, he is a

behavioral psychologist, and is the only person

to win the Nobel Prize for Economics

without actually being an economist. He

applies his work to key areas of study like

business; it is because of his work, for example,

that we know that individuals irrationally

protect against losses more than they try to

achieve gains.

Here are a few topics and insights from the book

that may be particularly relevant to you and me:

• Experts rarely are better at predicting things

in their domain of expertise than non-experts.

• We are way too easily influenced by bad information.

• We don’t understand basic logic.

• We are really bad at estimating.

Experts versus non-experts

That first one might be a bit shocking, or it

might not have sunk in, so let me repeat it:

EXPERTS ARE RARELY BETTER AT PREDICTING

THINGS IN THEIR DOMAIN

OF EXPERTISE THAN NON-EXPERTS.

Besides the obvious things you should be

thinking (like you need to fire your stockbroker),

this fact has immense implications. For

example, if we want the answer to a complex

problem that deals with uncertainty, we may

be better off asking a group than a known

individual expert (like crowdsourcing).

Most importantly, experts are often wrong

because they simply over-estimate their own skill

– validated by everyone calling them an expert.

Could this be you or I in our businesses? We

should work together as a team to ensure that we

don’t individually get too confident. We should

put mechanisms in place at work to avoid “groupthink”

and ensure we seek out contrarian views

and allow all the members of the team to have

input when we are making decisions. And you

should probably not try to pick stocks based on

analysts’ recommendations.

We are too influenced

by bad Information

Examples in the book include the need to somehow

explain every day’s increase or decrease in the

stock market (which we blindly believe when we

hear it). Or problems our minds have with

anchoring – for example, if I ask you two questions:

1) “Did Gandhi die before or after age

144?” (quite obviously before), then 2) “How old

was Gandhi when he died?”, you will give me a

higher answer than someone who was asked a different

first question (“Did Gandhi die before or

after age 25?” – quite obviously after).

We don’t understand basic logic

Jar A contains 10 marbles, of which one is red. Jar

B contains 100 marbles, of which 8 are red. I give

you one chance to pick a marble for $1 million –

which do you pick? What if I told you that you

would get cancer unless you selected a red marble?

Incorrect answers to questions like this happen

all the time. It is why Kahneman won the Nobel

prize for economics – he essentially disproved the

rational markets theory of investing. We all know

(now) that humans generally fear losses more than

we seek gains, and we get invested in previous

outcomes that shouldn’t matter (like the stock

used to be at $50, so I’m not going to sell at $30

even though my best evidence says it is going to

fall further to $20). We also over-value losses

against each other, which is why we are (stupidly)

more afraid of a shark attack than a car accident.

So in our teams at work, we can do a few things:

Make sure everyone understands what a sunk cost

is and work to make decisions based on the future,

not the past – like if a software system isn’t working

and the plug needs to be pulled, PULL IT!

Don’t get lost in thinking you have to make it

work because we’ve already invested $xx million

on it. Make sure you leverage your finance teams

who are (hopefully) trained in things like statistics

and presenting information in a neutral way.

We are really bad at estimating

The average homeowner who renovates a

kitchen thinks it will cost $19,000 when in

reality it ends up costing $39,000.

When people are asked whether their restaurant

will succeed, the response rate is overwhelmingly

positive, above 80-90%. Even though most

restaurants fail. When told this, respondents said

what we would all say…’that won’t happen to me’.

Kahnenman faced this problem on a project he

was working on: He was working with a group

of experts on writing a textbook. They finished

some of it in a year, then assessed how long they

estimated it would take to finish, concluding two

years felt right. When they asked someone who

had been around these types of projects what the

typical results were, they said 40% never finished,

and it always took at least 7 years! The

group, of course, rejected this evidence as not representative

of THEIR project. The results? They

completed the book 8 years later…

So, finally some good news: Next time you

get critiqued for estimating poorly, tell the

person that you indeed also hope to win a

Nobel prize someday.

But seriously, the call to action here is to start

including way more contingency in your projects,

whether in dollars for a capital project or in time

for the process. In addition, find benchmarking

information and use it – if a software product

hasn’t worked for any of your competitors, don’t

be naïve and determine that you can make it work

because “you are better than those guys.”

Conclusion

If you aren’t scared about your decision-making

ability after reading this, you should be! For me

the moral of this story is that we need to work

together to ensure we make good decisions,

because left to our own devices, we are going to

struggle. For those of us who are leaders, we need

to find ways to ensure diverse opinions from our

teams are heard, and seek out feedback and information.

For all of us, we need to speak up when

we have an idea that goes against the grain,

because we may just be right!

external reporting, along with assisting in

corporate finance matters. He was recently

named to Treasury

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