Book Notes - The Art of Thinking Clearly
The art of thinking clearly by Rolf Dobelli is one of the best books to sharpen the psychological side of decision making. I loved the book here are my notes
Use below biases as a checklist when making investment or other decisions
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It is much more common that we overestimate our knowledge than that we underestimate it. Similarly, the danger of losing something stimulates us much more than the prospect of making a similar gain.
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Why do we act so irrationally? Because the downside to such behaviour is not always apparent. In the financial markets, things are clear: a financial option on a security always costs something. There is no such thing as a free option, but in most other realms, options seem to be free. This is an illusion, however. They also come at a price, but the price.
Risk means that the probabilities are known. Uncertainty means that the probabilities are unknown.
In the realm of uncertainty, though, it’s much harder to make decisions.
Here are some which will enhance your thinking and decision process.
Never overestimate your chance of succeeding
In daily life, because triumph is made more visible than failure, you systematically overestimate your chances of succeeding.As an outsider, you succumb to an illusion, and you mistake how minuscule the probability of success really is. Rick, like so many others, is a victim of Survivorship Bias. For eg Behind every popular author you can find 100 other writers whose books will never sell. Behind them are another 100 who haven’t found publishers.
You should recognise that the survivorship bias is at work, distorting the probability of success like cut glass.Survivorship bias means this: people systematically overestimate their chances of success.
Clustering Illusion
The human brain seeks patterns and rules. In fact, it takes it one step further: if it finds no familiar patterns, it simply invents some.
When it comes to pattern recognition, we are oversensitive. Regain your scepticism. If you think you have discovered a pattern, first consider it pure chance.
Social proof
Social proof sometimes termed as herd instinct, dictates that individuals feel they are behaving correctly when they act the same as other people. In other words, the more people who follow a certain idea, the better (truer) we deem the idea to be. And the more people who display a certain behaviour the more appropriate this behaviour is judged to be by others. This is, of course, absurd.
Social proof is the evil behind bubbles and stock market panic.
‘If 50 million people say something foolish, it is still foolish.’‘If 50 million people say something foolish, it is still foolish.’
Sunk cost fallacy
Investors frequently fall victim to sunk cost fallacy.often they base their trading decisions on acquisition prices.‘I lost so much money with this stock, I can’t sell it now,’counts is the stock’s future performance (and the future performance of alternative investments). Ironically, the more money a share loses, the more investors tend to stick by it. This irrational behaviour is driven by a need for consistency. After all, consistency signifies credibility.
The acquisition price should play no role. What counts is the stock’s future performance (and the future performance of alternative)
Rational decision-making requires you.No matter how much you have already invested, only your assessment of the future costs and benefits counts.
Confirmation Bias
The confirmation bias is the mother of all misconceptions. It is the tendency to interpret new information so that it becomes compatible with our existing theories, beliefs and convictions.
‘Facts do not cease to exist because they are ignored,’ said writer Aldous Huxley. However, we do exactly that, as super-investor Warren Buffett knows: ‘What the human being is best at doing, is
interpreting all new information so that their prior conclusions remain intact.’
Authority Bias
whenever you are about to make a decision, think about which authority figures might be exerting an influence on your reasoning. And when you encounter one in the flesh, do your best to challenge him or her.
Contrast Effect
A product that has been reduced from $100 to $70 seems better value than product that has always cost $70
Availability Bias
The availability bias says this: we create a picture of the world using the examples that most easily come to mind. This is absurd, of course, because in reality things don’t happen more frequently just because we can conceive of them more easily.We think dramatically, not quantitatively.
Story Bias
Stories attract us; abstract details repel us. Consequently, entertaining side issues and backstories are prioritised over relevant facts.
Hindsight Bias
Always maintain and keep a diary.Write down your predictions – for political changes, your career, your weight, the stock market and so on. Then, from time to time, compare your notes with actual developments.
Overconfidence Bias
Always be aware that you tend to overestimate your knowledge.Be sceptical of predictions,especially if they come from so-called experts.And with all plans,favour the pessimistic scenario.
Chauffeur Knowledge
First, we have real knowledge. We see it in people who have committed a large amount of time and effort to understanding a topic. The second type is chauffeur knowledge – knowledge from people who have learned to put on a show. Maybe they have a great voice or good hair, but the knowledge they espouse is not their own. They reel off eloquent words as if reading from a script.true experts recognise the limits of what they know and what they do not know. If they find themselves outside their circle of competence, they keep quiet or simply say, ‘I don’t know.’ This they utter unapologetically, even with a certain pride. From chauffeurs, we hear every line except this.
Incentive Super
People respond to incentives by doing what is in their best interests.My advice: forget hourly rates and always negotiate a fixed price in advance.
The regression-to-mean delusion.
The most successful stock picks from the past three years are hardly going to be the most successful stocks in the coming three years. Knowing this, you can appreciate why some athletes would rather not make it on to the front pages of the newspapers: subconsciously they know that the next time they race, they probably won’t achieve the same top result – which has nothing to do with the media attention, but is to do with natural variations in performance
Outcome Bias
we tend to evaluate decisions based on the result rather than on the decision process. This fallacy is also known as the historian error.when randomness or ‘external factors’ play a role. A bad result does not automatically indicate a bad decision and vice versa. So rather than tearing your hair out about a wrong decision,remember why you chose what you did.
Neglect of Probability
People are equally afraid of a 99% chance as they are of a 1% chance of contamination by toxic chemicals. An irrational response, but a common one.
Scarcity error
Base-Rate neglect
Warren Buffett once explained why he does not invest in biotech companies: ‘How many of these companies make a turnover of several hundred million dollars? It simply does not happen?. . .?The most likely scenario is that these firms will just hover somewhere in the middle.’ This is clear base-rate thinking. For most people, survivorship bias (chapter 1) is one of the causes for their base-rate neglect. They tend to see only the successful individuals and companies,
The detailed description enticed us to overlook the statistical reality.
Gambler's Falacy
Complex feedback mechanisms in the atmosphere ensure that extremes balance themselves out. In other cases, however, extremes intensify. For example, the rich tend to get richer. A stock that shoots up creates its own demand to a certain extent, simply because it stands out so much – a sort of reverse compensation effect.
In real life, in the financial markets and in business, with the weather and your health, events are often interrelated. What has already happened has an influence on what will happen. As comforting an idea as it is, there is simply no balancing force out there for independent events. ‘What goes around, comes around’ simply does not exist.
The gambler’s fallacy leads us to believe that something must change.
Why evil strikes harder than good
The fear of losing something motivates people more than the prospect of gaining something of equal value. Suppose your business is home insulation. The most effective way of encouraging customers to purchase your product is to tell them how much money they are losing without insulation – as opposed to how much money they would save with it, even though the amount is exactly the same.
The downside is larger than the upside.We are more sensitive to negative than to positive things
Social Loafing
People behave differently in groups than when alone (otherwise there would be no groups). The disadvantages of groups can be mitigated by making individual performances as visible as possible. Long live meritocracy! Long live the performance society!
Winner's Curse
Bidding wars for cellphone frequencies drive telecom companies to the brink of bankruptcy. Airports rent out their commercial spaces to the highest bidder. And if Walmart plans to introduce a new detergent and asks for tenders from five suppliers, that’s nothing more than an auction – with the risk of the winner’s curse.
In large auctions, such as those for mining rights or mobile radio frequencies, we often observe the winner’s curse: here, the successful bidder turns out to be the economic loser when he gets caught up in the fervour and overbids.
Halo Effect
What emerges is not always pretty, but almost always educational.
Action & Self Serving Bias
Society at large still prefers rash action to a sensible wait-and-see strategy.If a situation is unclear, hold back until you can assess your options. ‘All of humanity’s problems stem from man’s inability to sit quietly in a room alone,’ wrote Blaise Pascal.
We attribute success to ourselves and failures to external factors. This is the self-serving bias.
Beginner's Luck
How do you tell the difference between beginner’s luck and the first signs of real talent?
There is no clear rule, but these two tips may help: first, if you are much better than others over a long period of time, you can be fairly sure that talent plays a part. (Unfortunately,
Second, the more people competing, the greater the chances are that one of them will repeatedly strike lucky. Perhaps even you. If, among ten competitors, you establish yourself as a market leader over many years, you can clap yourself on the back. That’s a sure indication of talent. But, if you are top dog among 10 million players (i.e. in the financial markets) in one particular year, you shouldn’t start visualising a Buffettesque financial empire just yet; it’s extremely likely that you have simply been very fortunate.
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