Why We Make Bad Decisions – Errors in Odds and Errors in Value
“An expert is someone who has succeeded in making decisions and judgments simpler through knowing what to pay attention to and what to ignore.” — Edward de Bono
Would life be better if somebody could tell us the right thing to do at all possible times?
Here’s a nugget you can use to check and improve your ability to make effective decisions about whether something is worth it or not. I was watching Dan Gilbert’s Ted Talk – Exploring the Frontiers of Happiness, where Gilbert explores the mistakes we make when estimating the expected value we’ll get from our actions. According to Gilbert, we have a tool to help us do the right thing at all possible times, but the problem is we can’t use it effectively because we can’t estimate odds and we can’t estimate value.
Dan Gilbert – Exploring the Frontiers of Happiness
Here is the video:
Daniel Bernoulli gave us a formula for help us figure out the expected value of something. The gist is this:
Expected Value = the product of two things (odds of gain) x (value of gain)
What this means is that if we can estimate and multiply the odds and the value of the gain, we would know exactly how we should behave. In other words, if we can effectively estimate the odds of our success and if we can estimate the value of our gain or our success, then we can better estimate the value, and know whether it’s worth it.
To highlight this, Gilbert shares a simple example. In a coin toss, if it comes up heads, you get $10. Should you pay $4 to play? Using Bernoulli’s formula, odds are 1/2 that the coin will come up heads, and the value of the gain is $10, so (1/2) x ($10) = $5. Since it would cost you $4, then according to Bernoulli’s formula, it’s worth it in this case.
The problem is, in real life the examples aren’t so simple and we make mistakes when we estimate the odds and the value.
Two Errors We Make
We make two errors when making decisions:
- 1. the odds
- 2. the value
We overestimate or underestimate the odds of success and we overestimate or underestimate how much we will actually value the gain.
Errors in Odds
We overestimate or underestimate the odds that it will happen. For example, when surveyed, people vastly overestimate how many people die from fireworks or tornadoes. At the same time, they vastly underestimate how many people die from Asthma or drowning. Why? Because we base it on what we’re familiar with or can easily see in our mind, whether it’s from the media or our own experience.
Errors in Value
According to Gilbert, estimating odds is a piece of cake compared to estimating the value. We make a couple of mistakes here. One mistake is that we compare the scenario to the past instead of the possibilities. For example, if you lost your ticket on the way to the movies, you won’t buy another one because you already spend the $10. On the other hand, if you lost $10 on the way to the movies, you would still spend another $10 to buy the ticket. In both cases, you’re down $10. In the first case, you compare it to the past where you only spent $10 on a ticket and buying another would make it feel like you’re spending $20.
Another mistake we make is when we compare at the time of purchase, but not our actual experience. For example, at the music store, the stereo might sound better compared to another one. When we play it at home though, we will never compare that experience again. In another example, we might pick a wine based on prices compared to other extreme prices on the shelf, but when we’re home we’ll just be comparing the taste.
3 Ways to Make Better Decisions
You can turn this insight into action using some quick checks whenever you need to make a decision:
- Ask yourself how you can check or better assess the actual odds of success.
- Rather than compare to the past, compare to the possibilities and net results.
- Rather than comparing against the immediate options on the table, test the value against the actual experience. (For example, A might look better than B in the show room, but B might be a better fit for your actual scenario.)
When I can’t easily verify the odds, one thing that helps me sometimes is just asking some questions. For example, if a doctor or mechanic wants to go down a certain path, I’ll ask them how many they’ve dealt with before and what their success rate is. There’s a big difference whether this is somebody’s first time or if they’ve seen this 100 times before.
My Related Posts
- 5 Elements of a Decision-Making Process
- Opinions Over Facts for Effective Decision Making
- What is the Relevant Decision Making Criteria
Photo by ralphrepo.