by Rolf Dobelli
Sometimes I have the dubious honor of speaking in front of students of elite business schools. When I ask them about their career prospects, most answer that, in the medium term, they see themselves on the boards of global companies. Years ago, both my fellow students and I gave the same answer. The way I see it, my role is to give students a base-rate crash course: “With a degree from this school, your chance of landing a spot on the board of a Fortune 500 company is less than 0.1 percent. No matter how smart and ambitious you are, the most likely scenario is that you will end up in middle management.” With this, I earn shocked looks and tell myself that I have made a small contribution toward mitigating their future midlife crises.
29
Why the “Balancing Force of the Universe” Is Baloney
Gambler’s Fallacy
In the summer of 1913, something incredible happened in Monte Carlo. Crowds gathered around a roulette table and could not believe their eyes. The ball had landed on black twenty times in a row. Many players took advantage of the opportunity and immediately put their money on red. But the ball continued to come to rest on black. Even more people flocked to the table to bet on red. It had to change eventually! But it was black yet again—and again and again. It was not until the twenty-seventh spin that the ball eventually landed on red. By that time, the players had bet millions on the table. In a few spins of the wheel, they were bankrupt.
The average IQ of pupils in a big city is 100. To investigate this, you take a random sample of fifty students. The first child tested has an IQ of 150. What will the average IQ of your fifty students be? Most people guess 100. Somehow, they think that the super-smart student will be balanced out—perhaps by a dismal student with an IQ of 50 or by two below-average students with IQs of 75. But with such a small sample, that is very unlikely. We must expect that the remaining forty-nine students will represent the average of the population, so they will each have an average IQ of 100. Forty-nine times 100 plus one IQ of 150 gives us an average of 101 in the sample.
The Monte Carlo example and the IQ experiment show that people believe in the “balancing force of the universe.” This is the gambler’s fallacy. However, with independent events, there is no harmonizing force at work: A ball cannot remember how many times it has landed on black. Despite this, one of my friends enters the weekly Mega Millions numbers into a spreadsheet, and then plays those that have appeared the least. All this work is for naught. He is another victim of the gambler’s fallacy.
The following joke illustrates this phenomenon: A mathematician is afraid of flying due to the small risk of a terrorist attack. So, on every flight he takes a bomb with him in his hand luggage. “The probability of having a bomb on the plane is very low,” he reasons, “and the probability of having two bombs on the same plane is virtually zero!”
A coin is flipped three times and lands on heads on each occasion. Suppose someone forces you to spend thousands of dollars of your own money betting on the next toss. Would you bet on heads or tails? If you think like most people, you will choose tails, although heads is just as likely. The gambler’s fallacy leads us to believe that something must change.
A coin is tossed fifty times, and each time it lands on heads. Again, with someone forcing you to bet, do you pick heads or tails? Now that you’ve seen an example or two, you’re wise to the game: You know that it could go either way. But we’ve just come across another pitfall: the classic déformation professionnelle (professional oversight; see chapter 92) of mathematicians: Common sense would tell you that heads is the wiser choice, since the coin is obviously loaded.
In chapter 19, we looked at regression to mean. An example: If you are experiencing record cold where you live, it is likely that the temperature will return to normal values over the next few days. If the weather functioned like a casino, there would be a 50 percent chance that the temperature would rise and a 50 percent chance that it would drop. But the weather is not like a casino. Complex feedback mechanisms in the atmosphere ensure that extremes balance themselves out. In other cases, however, extremes intensify. For example, the rich tend to get richer. A stock that shoots up creates its own demand to a certain extent, simply because it stands out so much—a sort of reverse compensation effect.
So, take a closer look at the independent and interdependent events around you. Purely independent events really only exist at the casino, in the lottery, and in theory. In real life, in the financial markets and in business, with the weather and your health, events are often interrelated. What has already happened has an influence on what will happen. As comforting an idea as it is, there is simply no balancing force out there for independent events. “What goes around, comes around” simply does not exist.
30
Why the Wheel of Fortune Makes Our Heads Spin
The Anchor
When was Abraham Lincoln born? If you don’t know the year off the top of your head, and your smartphone battery has just died, how do you answer this? Perhaps you know that he was president during the Civil War in the 1860s and that he was the first U.S. president to be assassinated. Looking at the Lincoln Memorial in Washington, you don’t see a young, energetic man but something more akin to a worn-out sixty-year-old veteran. The memorial must depict him at the height of his political power, say, at the age of sixty. Let’s assume that he was assassinated in the mid-1860s, making 1805 our estimate for the year he was born. (The correct answer is 1809.) So how did we work it out? We found an anchor to help us—the year 1865—and worked from there to an educated guess.
Whenever we have to guess something—the length of the Mississippi River, population density in Russia, the number of nuclear power plants in France—we use anchors. We start with something we are sure of and venture into unfamiliar territory from there. How else could we do it? Just pick a number off the top of our heads? That would be irrational.
Unfortunately, we also use anchors when we don’t need to. For example, one day in a lecture, a professor placed a bottle of wine on the table. He asked his students to write down the last two digits of their Social Security numbers and then decide if they would be willing to spend that amount on the wine. In the auction that followed, students with higher numbers bid nearly twice as much as students with lower numbers. The Social Security digits worked as an anchor—albeit in a hidden and misleading way.
The psychologist Amos Tversky conducted an experiment involving a wheel of fortune. He had participants spin it, and afterward they were asked how many member states the United Nations has. Their guesses confirmed the anchor effect: The highest estimates came from people who had spun high numbers on the wheel.
Researchers Russo and Shoemaker asked students in what year Attila the Hun suffered his crushing defeat in Europe. Just like the example with Social Security numbers, the participants were anchored—this time with the last few digits of their telephone number. The result? People with higher numbers chose later years and vice versa. (If you were wondering, Attila’s demise came about in 453.)
Another experiment: Students and professional real estate agents were given a tour of a house and asked to estimate its value. Beforehand, they were informed about a (randomly generated) listed sales price. As might be expected, the anchor influenced the students: The higher this price, the higher they valued the property. And the professionals? Did they value the house objectively? No, they were similarly influenced by the random anchor amount. The more uncertain the value of something—such as real estate, company stock, or art—the more susceptible even experts are to anchors.
Anchors abound, and we all clutch at them. The “recommended retail price” printed on many products is nothing more than an anchor. Sales professionals know they must establish a price at an early stage—long before they have an offer. Also, it has been proven that if teachers know students’ past grades, it influences how they will mark new work. The most recent grades act as a starting point.
In
my early years, I had a quick stint at a consulting firm. My boss was a pro when it came to using anchors. In his first conversation with any client, he made sure to fix an opening price, which, by the way, almost criminally exceeded our internal costs: “I’ll tell you this now so you’re not surprised when you receive the quote, Mr. So-and-So: We’ve just completed a similar project for one of your competitors and it was in the range of five million dollars.” The anchor was dropped: The price negotiations started at exactly five million.
31
How to Relieve People of Their Millions
Induction
A farmer feeds a goose. At first, the shy animal is hesitant, wondering: “What’s going on here? Why is he feeding me?” This continues for a few more weeks until, eventually, the goose’s skepticism gives way. After a few months, the goose is sure: “The farmer has my best interests at heart.” Each additional day’s feeding confirms this. Fully convinced of the man’s benevolence, the goose is amazed when he takes it out of its enclosure on Christmas Day—and slaughters it. The Christmas goose fell victim to inductive thinking, the inclination to draw universal certainties from individual observations. Philosopher David Hume used this allegory back in the eighteenth century to warn of its pitfalls. However, it’s not just geese that are susceptible to it.
An investor buys shares in stock X. The share price rockets, and at first he is wary. “Probably a bubble,” he suspects. As the stock continues to rise, even after months, his apprehension turns into excitement: “This stock may never come down,” especially since every day this is the case. After half a year, he invests his life savings in it, turning a blind eye to the huge cluster risk this poses. Later, the man will pay for his foolish investment. He has fallen hook, line, and sinker for induction.
Inductive thinking doesn’t have to be a road to ruin, though. In fact, you can make a fortune with it by sending a few e-mails. Here’s how: Put together two stock market forecasts—one predicting that prices will rise next month and one warning of a drop. Send the first mail to fifty thousand people and the second mail to a different set of fifty thousand. Suppose that after one month, the indices have fallen. Now you can send another e-mail, but this time only to the fifty thousand people who received a correct prediction. These fifty thousand you divide into two groups: The first half learns that prices will increase next month, and the second half discovers they will fall. Continue doing this. After ten months, around a hundred people will remain, all of whom you have advised impeccably. From their perspective, you are a genius. You have proven that you are truly in possession of prophetic powers. Some of these people will trust you with their money. Take it and start a new life in Brazil. Taleb describes this trick in Fooled by Randomness, however, with only 10,000 names.
However, it’s not just naive strangers who get deceived in this way; we constantly trick ourselves, too. For example, people who are rarely ill consider themselves immortal. CEOs who announce increased profits in consecutive quarters deem themselves infallible—their employees and shareholders do, too. I once had a friend who was a base jumper. He jumped off cliffs, antennae, and buildings, pulling the rip cord only at the last minute. One day, I brought up how risky his chosen sport is. He replied quite matter-of-factly: “I’ve over a thousand jumps under my belt, and nothing has ever happened to me.” Two months later, he was dead. It happened when he jumped from a particularly dangerous cliff in South Africa. This single event was enough to eradicate a theory confirmed a thousand times over.
Inductive thinking can have devastating results. Yet we cannot do without it. We trust that, when we board a plane, aerodynamic laws will still be valid. We imagine that we will not be randomly beaten up on the street. We expect that our hearts will still be beating tomorrow. These are confidences without which we could not live, but we must remember that certainties are always provisional. As Benjamin Franklin said, “Nothing is certain but death and taxes.”
Induction seduces us and leads us to conclusions such as: “Mankind has always survived, so we will be able to tackle any future challenges, too.” Sounds good in theory, but what we fail to realize is that such a statement can only come from a species that has lasted until now. To assume that our existence to date is an indication of our future survival is a serious flaw in reasoning. Probably the most serious of all.
32
Why Evil Is More Striking Than Good
Loss Aversion
On a scale of 1 to 10, how good do you feel today? Now consider what would bring you up to a perfect 10. That vacation in the Caribbean you’ve always dreamed of? A step up the career ladder, maybe? Next question: What would make you drop down by the same number of points? Paralysis, Alzheimer’s, cancer, depression, war, hunger, torture, financial ruin, damage to your reputation, losing your best friend, your children getting kidnapped, blindness, death? The long list of possibilities makes us realize just how many obstacles to happiness exist; in short, there are more bad things than good—and they are far more consequential.
In our evolutionary past, this was even more the case. One stupid mistake and you were dead. Everything could lead to your rapid departure from the game of life—carelessness on the hunt, an inflamed tendon, exclusion from the group, and so on. People who were reckless or gung ho died before they could pass their genes on to the next generation. Those who remained, the cautious, survived. We are their descendants.
So, no wonder we fear loss more than we value gain. Losing $100 costs you a greater amount of happiness than the delight you would feel if I gave you $100. In fact, it has been proven that, emotionally, a loss “weighs” about twice that of a similar gain. Social scientists call this loss aversion.
For this reason, if you want to convince someone about something, don’t focus on the advantages; instead highlight how it helps them dodge the disadvantages. Here is an example from a campaign promoting breast self-examination (BSE): Two different leaflets were handed out to women. Pamphlet A urged: “Research shows that women who do BSE have an increased chance of finding a tumor in the early, more treatable state of the disease.” Pamphlet B said: Research shows that women who do not do BSE have a decreased chance of finding a tumor in the early, more treatable state of the disease.” The study revealed that pamphlet B (written in a “loss frame”) generated significantly more awareness and BSE behavior than pamphlet A (written in a “gain frame”).
The fear of losing something motivates people more than the prospect of gaining something of equal value. Suppose your business is home insulation. The most effective way of encouraging customers to purchase your product is to tell them how much money they are losing without insulation—as opposed to how much money they would save with it, even though the amount is exactly the same.
This type of aversion is also found on the stock market, where investors tend to simply ignore losses on paper. After all, an unrealized loss isn’t as painful as a realized one. So they sit on the stock, even if the chance of recovery is small and the probability of further decline is large. I once met a man, a multimillionaire, who was terribly upset because he had lost a $100 bill. What a waste of emotion! I pointed out that the value of his portfolio fluctuated by at least $100 every second.
Management gurus push employees in large companies to be bolder and more entrepreneurial. The reality is: Employees tend to be risk averse. From their perspective, this aversion makes perfect sense: Why risk something that brings them, at best, a nice bonus, and at worst, a pink slip? The downside is larger than the upside. In almost all companies and situations, safeguarding your career trumps any potential reward. So, if you’ve been scratching your head about the lack of risk taking among your employees, you now know why. (However, if employees do take big risks, it is often when they can hide behind group decisions. Learn more in chapter 33 on social loafing.)
We can’t fight it: Evil is more powerful and more plentiful than good. We are more sensitive to negative than to posi
tive things. On the street, scary faces stand out more than smiling ones. We remember bad behavior longer than good—except, of course, when it comes to ourselves.
33
Why Teams Are Lazy
Social Loafing
Maximilian Ringelmann, a French engineer, studied the performance of horses in 1913. He concluded that the power of two animals pulling a coach did not equal twice the power of a single horse. Surprised by this result, he extended his research to humans. He had several men pull a rope and measured the force applied by each individual. On average, if two people were pulling together, each invested just 93 percent of his individual strength, when three pulled together, it was 85 percent, and with eight people, just 49 percent.
Science calls this the social loafing effect. It occurs when individual performance is not directly visible; it blends into the group effort. It occurs among rowers, but not in relay races, because here, individual contributions are evident. Social loafing is rational behavior: Why invest all of your energy when half will do—especially when this little shortcut goes unnoticed? Quite simply, social loafing is a form of cheating of which we are all guilty even if it takes place unconsciously, just as it does with the horses.
When people work together, individual performances decrease. This isn’t surprising. What is noteworthy, however, is that our input doesn’t grind to a complete halt. So what stops us from putting our feet up and letting the others do the hard work? The consequences. Zero performance would be noticed, and it brings with it weighty punishments, such as exclusion from the group or vilification. Evolution has led us to develop many fine-tuned senses, including how much idleness we can get away with and how to recognize it in others.
Social loafing does not occur solely in physical performance. We slack off mentally, too. For example, in meetings, the larger the team, the weaker our individual participation. However, once a certain number of participants are involved, our performance plateaus. Whether the group consists of twenty or one hundred people is not important—maximum inertia has been achieved.