We, human beings, often make terrible decisions and I will try to explain why. We usually don't feel that way, but we know it to be true; if everybody would always make the right decision, we would all be successful and happy. Also my crypto friends who regularly trade coins on different exchanges will know this: 90% of investors make "bad choices" and let emotions rule their decisions instead of rationally weighing the odds or risk against potential gains.
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But also in everyday life we're just not that good at it, even if the "rules" to come to a good decision are quite simple. Mathematician Daniel Bernoulli gave us a simple equation to predict the effectiveness of any given decision: the expected value of an action (V) is equal to the product of the odds (O) that the action will be profitable and the size of the profit (P): V = O x P.
So, in my imaginary casino it costs $9.00 to bet on red or black, and if you win, the house pays you $20.00. Anybody would take that bet because of Bernoulli's equation: the odds to win are 50%, the value of the award is $20.00, so 50% x 20 = $10.00 and that's more than the investment of $9.00. This is also the reason this casino will forever stay an imaginary one. Or a bankrupt one...
It seems easy that way, but we are terribly bad at estimating the two most important parts of the equation: we're terrible at estimating odds or risks, and we're terrible at estimating the gain or profit. And much of the cause of that lies in the way our brain works; we assign higher odds to things that come faster to mind. Let me give a a rather troubling real world example.
When asked what the odds are of certain causes of death, polls always result in the most unrealistic results. When asked how many people will die per year of tornadoes, fireworks, asthma and drowning, the results were:
Cause | Poll result | Actual number
tornadoes | 564 | 90
fireworks | 160 | 6
asthma | 506 | 1886
drowning | 1684 | 7380
You can see immediately that the first two are grossly overestimated and the last two equally underestimated. Tornadoes and fireworks come easier to mind because they get a lot of coverage and attention in our media, and I can't remember the last time a headline said "Boy Dies From Asthma!" This is also why so many people play and lose in lotteries: we see the winners in newspapers and on TV, they come to mind fast and easy. To expand on that: you're much more likely to die in a swimming pool than from terrorist attacks, plane-crashes and earthquakes combined.
Did you know that the National Lottery in many nations is referred to as "The Stupidity Tax" amongst economists?
"The odds of winning the lotto are so badly weighted against purchasing a ticket it can be thought as throwing money away. The real value of a $1 purchase is often as low as 32 cents, with the rest of the cost going straight into the profits of the ticket sellers. Those huge profit margins are why governments have increasingly turned to lotteries to raise funds, rather than through direct tax increases."
source: The Guardian
Another example of how we don't seem to be rational about these decisions can be seen in an imaginary mini-lottery. Let's say there are a total of 10 tickets and they cost $1.00 per ticket. If you win, you receive $20.00 dollar, and nine tickets are already sold to 9 other contestants. Now Bernoulli says it is a good decision to buy that last ticket because 20 / 10 = $2.00 The expected value is $2.00 which is double the price of your investment. Most people will rightly recognize this as a good deal and adhere to Bernoulli's equation.
Let's change one simple parameter and see what happens. Same scenario as before, only now the 9 tickets already sold are bought by one person, and you can buy the last one. Most people will not see this as a good deal, because it's much more difficult now to see yourself to win; the one person with 9 tickets will surely win! Now we don't buy the ticket anymore, even when the chance of winning hasn't changed one bit. Our inner instinct, our sense of fairness and assumption of an equal playing field prevent us from participating.
Our brain is a sort of prediction machine, a simulation center. We are unique in the sense that we can imagine a future by doing a simulation in our mind before actually doing something for real. The problem is however that the predictions are often subject to exaggeration, inflation and embellishment of all that's easy or satisfying to imagine.
Much of what's written here is inspired by the works of Dan Gilbert. Luckily for us, this simulating of happiness not only often lures us into making bad choices, it also is the same simulator that allow's us to feel good about live and ourselves despite the bad decisions it "forced" us into. Watch Dan Gilbert's "The surprising science of happiness":
The surprising science of happiness | Dan Gilbert
If you want further explanation or our bad decision making abilities, you should also watch Dan Gilbert on our bad choices in the below linked video. I never played the lottery. But I did get caught up in a FOMO frenzy once: FOMO stands for Fear Of Missing Out, and describes the fear traders have of missing out on some good profits during a bull-run in the market. I had to learn the "hard" way that you never buy when everyone else does; you buy when sentiments are bearish and prices are down. But our prediction machine often steers us in a direction we imagine to be right, when it actually isn't.
Why we make bad decisions | Dan Gilbert
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