And deprival super-reaction syndrome also comes in: You're going to lose the whole thing if you don't put in a little more. People go broke that way - because they can't stop, rethink and say, "I can afford to write this one off and live to fight
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again. I don't have to pursue this thing as an obsession - in a way that will break me." Part of what you must learn is how to handle mistakes and new facts that change the odds. Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand.
I've gotten so that I now use a kind of two-track analysis. First, what are the factors that really govern the interests involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things - which by and large are useful, but which often misfunction. One approach is rationality - the way you'd work out a bridge problem: by evaluating the real interests, the real probabilities and so forth. And the other is to evaluate the psychological factors that cause subconscious conclusions - many of which are wrong.
Take all the main models from psychology and use them as a checklist in reviewing outcomes in complex systems. No pilot takes off without going through his checklist: A, B, C, D ... And no bridge player who needs two extra tricks plays a hand without going down his checklist and figuring out how to do it... And, to repeat for emphasis, you have to pay special attention to combinatorial effects that create lollapalooza consequences.
Don't our feelings, instincts or our intuition help us avoid misjudgments?
Natural selection equipped us with traits adapted for the environment in which humans spent most of their time. Feelings like love, compassion, anger, fear, jealousy, and embarrassment can be explained biologically. They exist for a reason
to help us survive and reproduce. Somerset Maugham said: "Love is only a dirty trick played on us to achieve a continuation of the species." Why does sex feel good? Because it makes us reproduce. If sex felt painful, we wouldn't be here today. Our emotions are also part of the human whole. Our "good" emotions wouldn't be good without our "bad" emotions.
Feelings and instincts helped our ancestors navigate in the world. The ancestral environment rewarded actions before thought, emotion before reason. Fast intuitions and quick reactions are vital responses for organisms. Spending time pondering may be dangerous.
The problem is that feelings can be twisted. Intuition is inconsistent and feelings can sometimes get out of control. Especially when we feel uncertain, distracted or stressed.
Remember Chinese philosopher Lao-Tsu (604-531 BC): "He who knows men is clever; He who knows himself has insight; He who conquers men has force; He who conquers himself is truly strong."
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In Part Three we will study other reasons why we make misjudgments. These are partly rooted in our psychological make-up; our tendency to use crude rules of thumb, and make hasty judgments and other psychological tendencies discussed in Part Two. They also have their roots in a lack of considering some basic ideas from physics and mathematics.
Charles Munger gives us some introductory remarks on the value of knowing the methods of physics:
One of the things that influenced me greatly was studying physics.. .IfIwere running the world, people who are qualified to do physics would not be allowed to elect out of taking it. I think that even people who aren't [expecting to] go near physics and engineering [in their planned profession] learn a thinking system in physics that is not learned so well anywhere else. Physics was a total eye-opener.
The tradition of always looking for the answer in the most fundamental way available
- that is a great tradition and it saves a lot of time in this world. And, of course, the problems are hard enough that you have to learn to have what some people call assiduity. Well, I've always liked that word - because to me it means that you sit down on your ass until you've done it.
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- PART THREE -
THE PHYSICS AND MATHEMATICS OF MISJUDGMENTS
There will come a time when mathematical ignorance, like public smoking, will become socially unacceptable.
- Jerry King (Professor of Mathematics, from The Art of Mathematics)
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This part illustrates reasons for misjudgments and mistakes that can be reduced by considering some basic principles from physics and mathematics. The big ideas are explained using examples from business, investing, law, medicine, etc. As in Part Two, we begin with a list of the causes of misjudgments and mistakes. Each item on the list will be explained over the next chapters.
Systems thinking
Failing to consider that actions have both intended and unintended consequences. Includes failing to consider secondary and higher order consequences and inevitable implications.
Failing to consider the whole system in which actions and reactions take place, the important factors that make up the system, their relationships and effects of changes on system outcome.
Failing to consider the likely reactions of others - what is best to do may depend on what others do.
Failing to consider the implications of winning a bid - overestimating value and paying too much.
Overestimating predictive ability or usmg unknowable factors m making predictions.
Scale and limits
Failing to consider that changes in size or time influence form, function and behavior.
Failing to consider breakpoints, critical thresholds or limits
Failing to consider constraints - that a system's performance is constrained by its weakest link.
Causes
Not understanding what causes desired results.
Believing cause resembles its effect - that a big effect must have a big or complicated cause.
Underestimating the influence of randomness in bad or good outcomes.
Mistaking an effect for its cause. Includes failing to consider that many effects may originate from one common root cause.
Attributing outcome to a single cause when there are multiple causes.
Mistaking correlation for cause.
Failing to consider that an outcome may be consistent with alternative explanations.
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Drawing conclusions about causes from selective data. Includes identifying the wrong cause because it seems the obvious one based on a single observed effect. Also failing to consider information or evidence that is missing.
Not comparing the difference in conditions, behavior and factors between negative and positive outcomes in similar situations when explaining an outcome.
Numbers and their meaning
Looking at isolated numbers -failing to consider relationships and magnitudes. Includes not using basic math to count and quantify. Also not differentiating between relative and absolute risk.
Underestimating the effect of exponential growth.
Underestimating the time value of money.
Probabilities and number of possible outcomes
Underestimating risk exposure in situations where relative frequency (or comparable data) and/or magnitude of consequences is unknown or changing over time.
Underestimating the number of possible outcomes for unwanted events. Includes underestimating the probability and severity of rare or extreme events.
Overestimating the chance of rare but widely publicized and highly emotional events and underestimating the chance of common but less publicized events.
Failing to consider both probabilities and consequences (expected value).
Believing events where chance plays a role are self-correcting - that previous outcomes of independent events have predictive value in determining future outcomes.
Believing one can control the outcome of events where chance is involved.
Judging financial decisions by evaluating gains and losses instead of final state of wealth and personal value.
Failing to consider the consequences of being wrong.
&n
bsp; Scenarios
Overestimating the probability of scenarios where all of a series of steps must be achieved for a wanted outcome. Also underestimating opportunities for failure and what normally happens in similar situations.
Underestimating the probability of systems failure - scenarios composed of many parts where system failure can happen one way or another. Includes
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failing to consider that time horizon changes probabilities. Also assuming independence when it is not present and/or assuming events are equally likely when they are not.
Not adding a factor of safety for known and unknown risks. Size of factor depends on the consequences of failure, how well the risks are understood, systems characteristics and degree of control.
Coincidences and miracles
Underestimating that surprises and improbable events happen, somewhere, sometime, to someone, if they have enough opportunities (large enough size or time) to happen.
Looking for meaning, searching for causes and making up patterns for chance events, especially events that have emotional implications.
Failing to consider cases involving the absence of a cause or effect.
Reliability of case evidence
Overweighing individual case evidence and under-weighing the prior probability (probability estimate of an event before considering new evidence that might change it) considering for example, the base rate (relative frequency of an attribute or event in a representative comparison group), or evidence from many similar cases. Includes failing to consider the probability of a random match, and the probability of a false positive and false negative. Also failing to consider a relevant comparison population that bears the characteristic we are seeking.
Misrepresentative evidence
Failing to consider changes in factors, context or conditions when using past evidence to predict likely future outcomes. Includes not searching for explanations to why past outcome happened, what is required to make past record continue, and what forces can change it.
Overestimatingevidence from a single case or small or unrepresentativesamples.
Underestimating the influence of chance in performance (success and failure).
Only seeing positive outcomes - paying little or no attention to negative outcomes and prior probabilities.
Failing to consider variability of outcomes and their frequency.
Failing to consider regression - in any series of events where chance is involved unique outcomes tends to regress back to the average outcome.
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- ONE -
SYSTEMS THINKING
Wanted and unwanted consequences
In one of Aesop's fables the following story is told:
A poor widow living alone in the country kept a faithful hen. Each morning the hen laid a big, brown egg for the woman's breakfast. One day the widow thought to herself: "Now ifI were to double my hen's allowance of barley, she would lay me two eggs a day instead of one." So she started feeding her biddy a double measure of grain, and soon the hen began to grow fat and sleek and lazy. It wasn't long before she stopped laying altogether.
Every action has consequences. Both intended and unintended. No matter how carefully we plan, we can't anticipate everything. Often we fail to consider what other events are likely to occur as a result of some action. Politics, medicine, welfare programs, technology, military actions and laws generate unintended consequences. Whatever we do (or don't do), there are multiple consequences. They might not be what we expect. In one study, traffic engineers found that adding new routes (like a more direct road) could make traffic go slower. During merging, cars drive closer to each other and therefore slow down. Furthermore, studies of car safety show that wearing seat belt makes drivers feel more secure, making them drive faster or more recklessly.
By solving one problem, we generate another one and sometimes create an even worse one.
There was a problem with mice on campus. The solution for exterminating the mice was to pay students $1 for every dead mouse they delivered. It worked! Until the students began breeding the mice in order to make more money.
Actions have consequences and consequences have further effects. Charles Munger gives an example regarding Medicare:
They had all these actuarial studies that showed the cost would be X. And the cost turned out to be more than 1OX... They didn't factor in the fact that effects have effects... they didn't think through the incentive effects of the way they were changing the rules. They
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created a system wherein they were reimbursing both doctors and hospitals, in effect, on a cost plus percentage of cost basis. The minute they did that, the hospitals and doctors found wonderful ways to talk the patients into buying all kinds of care that got reimbursed ... good for the hospital and good for the doctor, but bad for the patient and bad for the taxpayers.
Should good intentions eliminate bad consequences? No. Outcomes don't follow from intentions and intentions by definition apply only to intended consequences. But as Samuel Johnson said, "The road to hell is paved with good intentions." Isn't it more important to find out if the consequences are good rather than if the reasons are good? Ask: What are we trying to improve? What can reasonably be expected to happen? Are the net effects positive or negative?
Good thinking is better than good intentions. In the 18th Century, Pierre S. du Pont, a deputy to the French National Assembly said: "Bad logicians have committed more involuntary crimes than bad men have done intentionally."
But even good thinking can have undesired consequences. Charles Munger gives an example:
An excess of what seems like professionalism will often wind up hurting you horribly precisely because those careful procedures themselves often lead to overconfidence in their outcome... Long Term Capital Management, the well-known hedge fund recently collapsed as a result of its principals' overconfidence in their highly leveraged methods. And it collapsed despite those principals having IQ's that must have averaged 160 or more...Smart, hard-working people aren't exempt from professional disasters resulting from overconfidence. Often they just go aground in the more difficult voyages on which they choose to embark based on self appraisals in which they conclude that they have superior talents and methods. It is, of course, irritating that extra care in thinking isn't all good- that it also introduces extra error. But most good things have undesired "side effects." And thinking is no exception.
One way to reduce unintended consequences is to stop focusing on isolated factors and instead consider how our actions affect the whole system.
The whole system
Sales volume dropped and John suggested· "Why don't we reduce price? It's a sure-fire way to win back customers and boost sales. We make up on volume what we lose on price and as a result we increase our market share. Profits will surely rise. "
"Where did we go wrong? We lost market share. Profits and stock price declined. "
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Why didn't TransCorp's profit increase? They forgot to think about all the factors that influenced the outcome. They didn't anticipate the consequences of cutting prices. They didn't consider other factors and conditions that influenced the value of the business. Some were changed as a consequence of TransCorp's decision to reduce prices in anticipation of higher volumes. Volume increases affect costs and behavior and need for investments in operating assets. There may also have been production problems due to technical constraints or the price decrease wasn't enough to make customers switch from the competition.
How a system behaves is a function of all the factors (human and non-human) that make up and influence the system.
A system is a collection of parts working together as a whole. Take a business as an example. It is a collection of parts but works as a complete system. There are variables like suppliers, employees, customers, demand, competition, etc. There are activities like purchasing, manufacturing, warehousing, logistics, and distribution. There are technological systems and equi
pment needed to conduct the business. All these parts work together.
TransCorp fired 200 people to cut costs.
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