10 Ways To Make Better Decisions

Many of the decisions we make every day are subject to uncertainty. Should I accept the job offer? Should I start that business? Should I marry my partner?

But what process should you use? This article breaks down 10 tips for making better decisions under uncertainty; from when to rely on the wisdom of the crowds to why simple formulas can sometimes make for optimal decisions. You will also discover why taking the ‘outside view’ and practicing second level thinking can give you the edge on your competition. Each tip includes at least one action that you can introduce into your everyday life.

Tip number 1: Embrace uncertainty

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On 29th April 2011 former US President Barack Obama made one of his most difficult decisions. He had to decide whether to launch an attack on a compound in Pakistan that intelligence agents suspected to be the home of Osama bin Laden.

First, he was uncertain that bin Laden was actually residing in the compound. “As outstanding a job as our intelligence teams did,” said the President, “At the end of the day, this was still a 55/45 situation. I mean, we could not say definitively that bin Laden was there.”

Second, regardless of whether bin Laden was residing in the compound, it was uncertain that the operation would succeed. “You’re making your best call, your best shot, and something goes wrong — because these are tough, complicated operations.”

There are two forms of uncertainty: hidden information and randomness. Obama had to grapple with both of these on that night in 2011.

First was the uncertainty of hidden information. For example, was bin Laden in the compound? Second was the random uncertainty of all the possible ways the mission could unfold. For example, the possibility of mechanical failure.

Many of the decisions we make every day are also subject to the same types of uncertainty. Do I accept the job offer from the successful start-up company?

How embracing uncertainty can make you a better decision maker

Why is this important? Well, by not embracing uncertainty your decisions are likely to be incorrect, and risk creating bigger problems. The economist Kenneth Arrow (a weather forecaster during the Second World War) captured this sentiment well, “To me our knowledge of the way things work, in society or in nature comes trailing clouds of vagueness. Vast ills have followed a belief in certainty.”

Tip number 2: When to use your gut instinct

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Best-selling books extol the intuitive decisions of great businessmen and successful sportsmen. The lure of the split second decision that separated the good from the great is a story that we all like to hear. We like it because it satisfies our own yearning that we can achieve the same level of greatness.

Daniel Kahneman describes two systems of decision making. The first, ‘System 1’ is “fast, automatic, effortless, associative, and difficult to control or modify.” With System 1 we use perception and intuition to generate impressions of the world around us.

System 1 works pretty well for most of the decisions we make. Intuition is necessary because we don’t have the luxury of enough time to deliberate every decision.

Intuition works well in stable environments in which conditions are stable, where feedback is clear and where there is a linear relationship between cause and effect. Yet, System 1 has its flaws. Many of these are rooted in the “flight or fight” responses of our animal ancestors.

System 1 tends to fail in non-linear systems where the link between cause and effect are not linked, for example financial markets. In these kinds of systems the underlying statistical properties change over time. The past may not be a good predictor of the future. The second decision making system that Kahneman describes is ‘System 2’. In contrast to System 1 it is analytical and “slower, serial, effortful, and deliberately controlled.”

With deliberate practice anyone can embed these methods into their decision making process. With practice you will know when to trust your gut and when to seek the opinion of others. You will be able to free your mind to think further and faster than other people.

How to use your intuition to make better decisions

Tip number 3: The inside versus the outside view

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We typically make decisions by focusing on the specific task and by using information that is close at hand. In turn we make predictions based on that same narrow and unique set of inputs. The ‘inside view’ includes anecdotal evidence and erroneous perceptions.

We make the mistake of thinking we are representative of everyone else — but why? It all comes down to three illusions.

We suffer from the illusion of superiority. An example is that we tend to believe that we are above average in our abilities as a driver — of article we can’t all be above average. It gets worse. It’s often the least capable people that show the largest gap between what they think they can do, and what they actually can achieve.

We also suffer from the illusion of optimism. Many people think that the odds of the new restaurant they’ve launched lasting five years as being very high — sadly new restaurants often fail. Most people believe that their future is bright.

Finally, we suffer from the illusion of control. Think back to the last time you played the game Snakes & Ladders. Players typically throw the dice harder when they need a high number and vice versa for a lower number. People behave as if they have some control over events, even when chance plays a big if not total role in the outcome.

The ‘outside view’ is different. It asks if there are similar situations that can provide a statistical basis for making a decision. Rather than seeing a problem as unique, the outside view wants to know if others have faced comparable problems and, if so, what happened. The outside view is an unnatural way to think because it forces people to set aside all the cherished information they have gathered.

An example of this approach is how we view other people’s situations. Ever found it much easier to diagnose the solution to someone else problem than your own? When we help a friend or a colleague we expand the frame of reference, pick up on common patterns and remove emotion from the process. We make better decisions.

How to use the outside view to make better decisions

As Michael Mauboussin says in his book Think Twice, “The main tip from the inside-outside view is that while decision makers tend to dwell on uniqueness, the best decisions often derive from sameness.”

Tip number 4: The wisdom of crowds

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When we are confronted with a problem the normal question that comes to people’s minds is, “Who can I call on to help me out?”

Before you make that call its worth thinking about where experts actually add value. It is probably better to book a qualified plumber to repair a leaky pipe than dragging three random people off the street to help you. No doubt the same could be said for open heart surgery.

Experts are much less reliable at adding value when it comes to fields where the outcomes are diverse and subject to uncertainty. Business, investment and the economy for example are fields where the connection between cause and effect are far less clear.

Experts may also get stuck in old habits of thinking, unable or unwilling to use new techniques and adapt to a changing world. That point also applies to experts in fields as diverse as plumbing, surgery and business.

Groups can often solve problems much more efficiently and accurately than any single individual. The academic Francis Galton was one of the first to document this. Writing in 1907 he described a contest to guess the weight of an ox at an exhibition in Plymouth, England. Collecting a small entry fee from 787 participants he calculated the mean of the guesses — it was within 0.01% of the correct weight!

Other studies replicated these findings. From guessing the number of jellybeans in a jar to finding missing bombs, the wisdom of crowds surpassed the individual.

Three conditions must be in place to tap into the wisdom of crowds: diversity, aggregation and incentives. A diverse group of people reduces the collective error since over and under estimations should cancel each other out. Aggregation ensures that everyone’s information is accounted for. Finally, incentives encourage people to take part only when they think they have an insight.

Unchecked devotion to the wisdom of the crowds is folly! When one or more of the three conditions of the wisdom of crowds is unmet you should watch out. And the most important one to watch out for is diversity, which is also the most likely condition to fail.

Humans are social animals of article. We have a habit of following others and making decisions based on the actions of others. These so-called ‘information cascades’ explain booms and crashes in financial markets and why fashions come and go.

Extremes in markets and fashions tend to occur when everyone has the same opinion. The following quote from the book “Extraordinary Popular Delusions and the Madness of Crowds” describes how these extremes can occur — when diversity, the vital condition for the wisdom of crowds is missing. “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”

How to use the wisdom of the crowds to make better decisions

Tip number 5: Concentrate on the process, not the outcome

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Quite often we do not expect something to happen until it does. Only then do we see the forces that triggered the event, and feel unsurprised. Outcomes appear as if they should have been foreseeable.

Sadly, we are more likely to blame decision makers bad choices, rather than praise them for good choices. As the 19th century philosopher Søren Kierkegaard said, “Life is lived forwards, but understood backwards.”

“Hindsight bias” is the almost irresistible tendency to believe — after a sports game or an investment — that the outcome was foreseeable. After your favourite team loses (“the manager made a bad decision taking off the star player”), or the stock market drops (it “was due for a correction”), the outcome seems obvious — and thus blameworthy.

Separate skill from luck

Often we tend to think that the past was preordained, that there was no alternative future that could have happened. But as we know right now the future is anything but set in stone.

Yet, when a series of decisions turn out well we typically start to get overconfident. As the psychologist Daniel Kahneman illustrates, hindsight bias stands in the way of us getting the feedback we need to improve future decisions, “The illusion that we understand the past fosters overconfidence in our ability to predict the future.”

When a decision turns out well it’s important to separate what was luck from what was skill. If you can figure that out, you can improve future decisions and understand what you did correctly. Similarly, when a decision turns out bad understanding what was the best move relative to the probabilities, and that despite the outcome should be repeated in the future is just as significant.

How to avoid hindsight bias and make better decisions

Tip number 6: Second level thinking

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First-level thinking is simplistic and superficial, and everyone can do it. All the first-level thinker needs is an opinion about the future, for instance “That horse has won the past 5 races, it’s a shoe-in for the next race”.

In that sense first-level thinkers look for things that are simple, easy, and defendable. They fail to realise that they are dealing with complex systems, or if they do realise it, they mistake cause-and-effect relationships.

By contrast, second-level thinking is deep, complex and convoluted. The second-level thinker takes a great many things into account: what is the range of likely future outcomes?; which outcome do I think will occur?; what’s the probability I’m right?; what does the consensus think?; and how does my expectation differ from the consensus? If that happens, what will that mean for A, B and C, and if B subsequently happens what will that mean for Z?

One of the best examples of second level thinking comes from the economist John Maynard Keynes who wrote about a fictional newspaper contest. Out of 100 photographs, participants had to pick 6 faces whom they think is the ‘prettiest’. The person who has gotten the most choices right is the winner and will receive a prize.

Pause for a moment and imagine yourself to be a participant in this newspaper contest. How would you play this game? Faced with 100 smiling faces, how would you approach the task on hand and select the winner? According to Keynes:

“It is not a case of choosing those (faces) that, to the best of one’s judgement, are really the prettiest, nor even those that average opinion thinks the prettiest. We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”

Second level thinking is clearly hard work, and it carries risks too for those fearful of being wrong and looking foolish. Again, Keynes captured this best, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

That’s a mistake. Remember, conventional thinking gets conventional results. Think unconventionally.

How to use second level thinking to make better decisions

Tip number 7: Thinking in terms of bets

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A ‘real possibility’

What does that mean to you? To some people this means a probability of just 20%, but to others it means 80% likely. Author and investor Michael Maubaussan collated perceptions of probabilistic language in a survey. Some phrases, such as a ‘real possibility’ showed a wide range of answers.

So what you might ask? Why does this matter? Well, the danger with ‘faux’ certainty is that it might lead people to believe something is more likely than it actually is. If when asked by your boss, you describe completing the project on time as a ‘real possibility’ other decisions may be made on the basis that it will be delivered on time. The downside is a delay to the project and you are passed over for promotion.

Instead of relying on woolly language like ‘real possibility’ focus on probabilities. What are the chances that the decision will be correct or that the project will be completed on time?

By thinking about things in terms of probabilities we have to think about things from other people’s perspective. It encourages us to think, “Why am I wrong?” instead of “Why am I right?” It encourages us to ask ourselves, “How sure am I?” instead of “Am I sure?”

“Wanna bet?”

Former poker champion Annie Duke suggests that you take it one step further and think about decisions in terms of a bet. In most of our decisions, we’re not betting against another person, but rather all the future versions of ourselves that we are not choosing. At stake is that the return to us (happiness, money, time, health) will be greater than what we are giving up by betting against alternative futures.

Of article, in order for your decision making under uncertainty to improve you need feedback. Some events in life give us rapid and frequent feedback on the quality of our decisions (e.g. playing poker for example). Most feedback is infrequent and unclear. By incorporating probability based decision making into your daily life and gradually iterating your assessment as new information presents itself, you can quickly build-up useful feedback into your decision making process.

Life is one long game, and there are going to be a lot of losses, even after making the best possible bets. We are going to do better, and be happier, if we start by recognising that we’ll never be sure of the future.

How you can use thinking in terms of bets to make better decisions

Tip number 8: Keeping emotion in check

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Although a little bit of stress in our lives is a good thing, too much of it for too long and it starts to damage our health. Stress also has a big impact on our ability to make good decisions under uncertainty.

Stressed people struggle to think about the long term. We tend to place a greater emphasis on quick payoffs, even though longer term thinking is often the better decision.

Your emotion also can result in you missing vital pieces of information. In a famous experiment conducted in the late 1990’s two groups of people — some dressed in white, some in black — are passing basketballs back and forth. The study subjects were asked to count the passes among those dressed in white while ignoring the passes of those in black.

The researchers found that many of those who viewed the video failed to notice when a person in a gorilla suit walked into the game, faced the camera, pounded on its chest and then sauntered out of view. The gorilla was on screen for nearly nine seconds, yet half of those who watched the video didn’t see it.

Emotional intelligence

Avoid making decisions while at emotional extremes. Stress, anger, fear, anxiety, greed and euphoria are all mental states that tend to affect the quality of our decisions.

Emotions are not all bad of article. In fact since many of the decisions we make are about or at least affect other people. Empathy, i.e. understanding the emotion of others is one of the most powerful things you can do to improve your decision making.

Often many of the poor decisions we make result from inappropriate incentives rather than mistakes. While financial incentives are generally easy to spot others such as reputation, fairness, security, etc. are much less easy to spot. And many of these incentives change over time as peoples emotional state switches between extremes.

How keeping check of emotions can enable you to make better decisions

Tip number 9: Weighted pros and cons

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Often some of the biggest decisions we make in life are binary. Should I accept the job offer or stick with my current job? Should I move in with my girlfriend or stay with my friends? Should I move my family across the country to a new town, or stick with where we are now?

It has always been this way.

America’s Founding Father Benjamin Franklin reputation for wisdom meant that he was on the receiving end of countless pleas for advice. In 1772 his friend, English scientist Joseph Priestley was torn by a major life decision. He was offered a job that would give him financial stability, but it also meant he would have to move his family away several hundred miles to a new home in the south of England. Instead of telling his friend what to do, Franklin told his friend how to think.

The conventional advice, particularly for personal decisions, is to make a list of pros and cons. Implicit in a simple pros/cons list is that each pro and con has the same weight, that we value each the same and that the options have the same chance of success. Franklin told him to think about what matters.

Using this decision making method Priestley accepted the position and moved his family to the other side of the country. It proved to be a turning point in the history of science.

So let’s see how you can use this technique.

How to improve your decision making using pros and cons

Tip number 10: A formula for success?

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Recall from tip 4 that you should use the wisdom of crowds approach to making better decisions when there are a wide range of outcomes and the outcome is subject to considerable degree of probability. So when should you use a computer to make decisions?

When the principles are clear and well defined, computers tend to outperform experts or the crowd. Think of fields like credit scoring and simple medical diagnosis. But they are increasingly outperforming in other fields too?

The role of statistics in decision making under uncertainty was best popularised by the bestselling book Moneyball: The Art of Winning an Unfair Game by Michael Lewis. The book recounts the story of the Oakland Athletics baseball team pioneered the use of statistical modelling of player performance. By relying on computers rather than expert perception they were able to compete with teams with three times the budget.

The psychologist Philip Tetlock completed an exhaustive study of expert predictions, including 28,000 forecasts made by 300 experts from 50 countries over a period of 15 years. The predictions related to political and economic events with a wide range of outcomes. According to Tetlock, “It is impossible to find any domain in which humans clearly outperformed crude extrapolation algorithms, less still sophisticated statistical ones.”

Which house should I buy, when should I get married and to whom?

Over the article of our lifetimes we make a handful of big decisions. Who to marry? Which house to buy? What career to pursue? All are subject to uncertainty.

An algorithm may be able to help. The optimal solution to these problems (assuming you are trying to maximise your chances of getting the very best partner, job or house) is 37%. If you want the best odds spend 37% of the search time allocated noncommittally exploring options. According to the authors of the book “Algorithms to Live By”, this is not merely an intuitively satisfying compromise between looking and leaping, it is the provably optimal solution.

How using formulas can enable you to make better decisions

The tip from this article on decision making is that you can only do so much to improve your decision making. The problems that we face each day are hard, and there isn’t always the time to optimise the decision making process. I’ll finish this article with a quote from the book Algorithms to Live By: The Computer Science of Human Decisions:

“Don’t always consider all your options. Don’t necessarily go for the outcome that seems best every time. Make a mess on occasion. Travel light. Let things wait. Trust your instincts and don’t think too long. Relax. Toss a coin. Forgive, but don’t forget. To thine own self be true.”

I write about commodity markets at www.materials-risk.com. Author of a book about the power of media narratives and reclaiming your thinking.

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