Tag Archives: Story@BFBV

Story@BFBV: Watch Your Language!

What do you really mean when you say you are 90% sure about something? Are you really sure about what it means to be 90% sure? Probably not, according to several studies which show people are consistently overconfident about their beliefs, pretty much like the cat in the picture below:

One trick that makes it easier to visualize what a confidence level of 90% really means requires converting that confidence into a bet involving money. Here’s how.

Let’s say you are 90% sure that the stock market will close higher in 2010 than it did in 2009. If that is really the case i.e. if you are really 90% sure about your prediction, then you should be willing to win $1 in a bet but accept a loss of $9 if you lose. Why?

We already know that either you are right or you are wrong about your prediction. In fact, you are going to be right 90% of the time according to you. Thats what being 90% sure means. If that turns out to be the case, then the expected value of your winning is 90% of $1. That comes to +$0.90

You are going to be wrong 10% of the time according to you. That’s what being 90% sure means – that you will have an error rate of only 10%. If that turns out to be the case, then the expected value of your loss is 10% of $9. That comes to -$0.90.

Therefore, if you are 90% confident that the market will close higher in 2010 than in 2009, then this is a fair bet because it involves an equal exchange.

Put in those words, you may balk at the prospect of losing $9 versus winning only $1. But that is exactly what 90% confidence level means.

When your beliefs are framed in the form of money bets instead of confidence levels, you have a better chance of understanding the odds implied by your beliefs. Keep that in mind when you express confidence in your predictive abilities.

Watch your language!


Story@BFBV: The 12 Angry Men Story

The jury system has been designed to be a great system of decision making.

So what happens in a jury system? Watch 12 Angry Men. Its a great movie to observe psychological models at work.

12 not so angry men (or women) who are honorable and have no connection with the case are required to sit in a room and listen. They are not allowed to talk – the talking is done by the lawyers and the witnesses and the judge. The jury members are required to keep them minds open and their mouths shut and hear the proceedings of the case including the arguments brought forward by both sides. They are required to NOT DECIDE AT THIS POINT. No jumping to conclusions allowed. No first conclusion bias here. No confirmation bias either.

Then they are asked to go sit in a room and NOT COME OUT until they have a UNANIMOUS (or majority in some countries) decision. To arrive at the decision, they need to debate, discuss, look at different points of view, and only AFTER this has been done are they required to DECIDE.

This is a WONDERFUL system of decision making because it forces objectivity, removes first conclusion bias, and confirmation bias – IF IT WORKS. In reality, psychologically astute lawyers will use all the tricks in the trade to manipulate jury members – but at least in theory the jury system is a fabulous system – and strongly advice you to adopt it in your own decision making process.

Remember this: The decision to not decide now on a matter is also a decision. There is wisdom in the Chinese proverb: “My indecision is final.”


Story@BFBV: The Scott Fitzgerald Story

Fitzgerald was right. Almost always there is a reason to not to do something that you have decided to do.

People hate contradictions. They make you uncomfortable. You own a stock which is ridiculously cheap. The market, however, is not cheap. What should you do? Do you ignore the market or do you focus on the market and ignore the opportunity? Is there a way out of this contradiction?

Ben Franklin created a way to deal with contradictions. He called it Prudential Algebra. He described it in a letter he wrote to a friend in 1772:

“My way is, to divide half a sheet of paper by a line into two columns, writing over the one pro, and over the other con. Then during three or four days of consideration I put down under the different heads short hints of the different motives that at different times occur to me for or against the measure. When I have thus got them all together in one view, I endeavour to estimate their respective weights; and where I find two, one on each side, that seem equal, I strike them both out: If I find a reason pro equal to some two reasons con, I strike out the three. If I judge some two reasons con equal to some three reasons pro, I strike out the five; and thus proceeding I find at length where the balance lies; and if after a day or two of farther consideration nothing new that is of importance occurs on either side, I come to a determination accordingly. And though the weight of reasons cannot be taken with the precision of algebraic quantities, yet when each is thus considered separately and comparatively, and the whole lies before me, I think I can judge better, and am less likely to make a rash step; and in fact I have found great advantage from
this kind of equation, in what may be called Moral or Prudential Algebra. Wishing sincerely that you may determine for the best, I am ever, my dear Friend, Yours most affectionately – Ben Franklin”


Story@BFBV: The Swan Story

You can never really prove the proposition that “all swans are white” even if you spot a million of them and all of them turn out to be white. But you can certainly disprove the proposition that “all swans are white” by sighting a single black swan. Nassim Taleb’s explains Karl Popper’s powerful idea of falsification in his book, “The Black Swan.”

Evidence that confirms your exiting beliefs is not as powerful as evidence that disconfirms those beliefs.

Great scientists like Richard Feynman agree. He once said, “If you’re doing an experiment, you should report everything that you think might make it invalid — not only what you think is right about it. Details that could throw doubt on your interpretation must be given, if you know them. The exception tests the rule. Or, put another way, the exception proves that the rule is wrong. That is the principle of science. If there is an exception to any rule, and if it can be proved by observation, that rule is wrong.”

Learn to recognize and respect disconfirming evidence if you want to make good judgements. Most people do just the opposite. They seek out evidence that proves them right and ignore or discard evidence that proves them wrong.

Don’t fall in love with your ideas.



Story@BFBV: “I Have Too Much Invested in This” Story

If you have spent a month researching an idea, it does not become more attractive than a no-brainer flash you get which you are in the shower. The attractiveness of a stock comes from the difference between its intrinsic value and its market price, and the probability of the two converging. It does not come from the effort you have put into researching it.

Remember the experience you acquire by spending a month researching an idea which turns out to be not so good an idea after all counts towards the 10,000 hours of of experience you need to have to qualify as an expert.

Great scientists know the importance of this principle. Thomas Edison once said, “I have not failed. I’ve just found 10,000 ways that won’t work.”

Likewise, past actions don’t become worth continuing simply because you have too much invested into them. Many a bad marriage is continued because of this fallacy.

You are going to make mistakes. Recognize them, correct them, and move on. Don’t perpetuate your errors by rationalizing that “I have too much invested into this, and I can’t just write it off and start again.

Sunk costs (financial and emotional) are irrelevant for future decisions.


Story@BFBV: The Story of the Three-Legged Stool

I love this story of Cialdini’s Three Legged Stool. The stool is stable because it has three legs. Take one away and it will fall. However, this magical stool does not fall because when one leg is taken away, another one grows to replace it.

The human mind pretty much works like the three-legged-stool. You do something for a reason, and then more reasons are created in your mind to justify your decisions. And when the original reason for doing that thing is taken away, new reasons are invented to allow you to continue with the decision. You are never wrong this way because there are always enough reasons to maintain your prior beliefs.

Take an example. You buy a stock because you think its prospects are good. Then you learn that the company’s earning power will be hurting for the several years in the future. In the meantime, the stock has fallen 20% from your cost. You mind will now invent new reasons to hold on to the stock. You will start thinking that this is just a temporary adversity, or the drop in price has made it even a better bargain so you should buy more, or you have new cash coming in which you can invest in new opportunities so no point liquidating this position, or the company is developing a new product line and that will surely result in resumption of profit growth, or the company has become an attractive acquisition target and will surely be acquired at a large premium to the prevailing price, or blah blah blah – you get the point I think.

Is your mind the functional equivalent of the three-legged stool magically growing legs to allow you to be consistent with you past dumb calls?







Story@BFBV: The Swallow and Other Birds Story

It happened that a Countryman was sowing some hemp seeds in a field where a Swallow and some other birds were hopping about picking up their food. “Beware of that man,” quoth the Swallow. “Why, what is he doing?” said the others. “That is hemp seed he is sowing; be careful to pick up every one of the seeds, or else you will repent it.” The birds paid no heed to the Swallow’s words, and by and by the hemp grew up and was made into cord, and of the cords nets were made, and many a bird that had despised the Swallow’s advice was caught in nets made out of that very hemp. “What did I tell you?” said the Swallow.

Destroy the seed of evil, or it will grow up to your ruin.

Aesop’s story, which you possibly read as a child, is wise. There is a very wise man by the name of Lee Kuan Yew – the founder of Singapore. Mr Charlie Munger is a big fan of Mr. Lee. He encourages you to read his story in “From Third World to First: The Singapore Story: 1965-2000” Mr Lee followed the wise advice of the Swallow in this story. According to Mr. Munger, “Lee didn’t want people dying of Malaria so he drained all the swamps and didn’t care if a little fish went extinct. He didn’t like the drug problem and he looked around the world to solve the drug problem. He found the solution in US by copying the US Military’s policy. Any time you can be tested and if you fail you go to jail. If something was going to grow like cancer he would check it hard with the wrath of God. He turned a country with no resources or agriculture into a prosperous country.”

It’s very important to think about virtue and vice effects. Once something evil begins it spreads due to a combination of several psychological tendencies we have been talking about in BFBV. And then it gets rationalized. Its easy to be evil when everyone around you is also doing evil things. Which is why once evil is spotted, it must be nipped in the bud. Great leaders like Lee know and follow the advice of Swallow. It does not matter if some people are inconvenienced or treated unfairly. Great leaders think of the problem from the viewpoint of not individuals, but from the viewpoint of their civilization.

Read this book:



Story@BFBV: The Leon Festinger Story

Leon Festinger came up with one of the most brilliant ideas in social psychology: Cognitive Dissonance – the engine behind self justification of dumb things. Watch this video:

When people have two contradictory thoughts in their minds, they experience dissonance. The pressure to resolve that dissonance arises from the uncomfortable feeling of holding contradictory thoughts in one’s mind e.g. Smoking is bad for me, and I smoke. Typically people resolve dissonance by rationalizing their dumb behavior by convincing themselves that what they are doing is not dumb at all (e.g. “the studies that link smoking to cancer are fake,” “its my life,” “lots of smart people do it so it can’t be all that bad,” “I know a man who smokes three packs a day and he is 99 years old” etc etc.

Contrary to the fundamental assumption in economics that man is a rational animal, social psychologists like Leon Festinger showed that man is not a rational animal, rather he is a rationalizing animal. Cognitive dissonance theory explains why people stick to their bad judgments even when they are totally wrong.

Learn to promptly resolve cognitive dissonance rationally by changing your behavior when you are wrong instead of fooling yourself in believing that you are right.


Story@BFBV: Chains of Habit

Mr Buffett once said, “Chains of habit are too light to be felt, until they are too heavy to be broken.” Its very difficult to break a bad habit and therefore terribly important that you form the right mental habits early in life.

The chains of which bad mental habits are you a prisoner of? Break them early or you will be imprisoned for life…


Story@BFBV: The Fog of War Story

Everyone should watch Robert McNamara’s “The Fog of War.” I particularly liked Lesson # 7 (“Belief and Seeing are both often Wrong”) which deals with confirmation bias. According to McNamara, people see what they want to see. In this particular case, US Navy “saw” torpedoes when there weren’t any, and that led to the escalation of the Vietnam war resulting in horrible consequences. See Lesson # 7 from 05:22 onwards in this video:

and from the beginning to 00:59 in the following video:

Do you see what you only want to see and that which will confirm your prior beliefs?