How To Decide by Annie Duke
Few takeaways from the book:
- Gut instinct and intuition are seldom reliable decision-making tools (this point is also made in the book 'Thinking, Fast and Slow'- one of my all-time favourite books). This is why most (if not all) successful traders follow a 'system' defined by rules.
- There are two determinants of an outcome- decision quality and luck. The former is in our control, while the latter is not. Hence, it is important to articulate a rational decision-making process.
- Resulting (outcome bias): we often determine the quality of a decision based on the outcome. A good outcome leads us to believe we made a good decision, and vice-versa. While there must be a strong correlation between decision quality and outcome quality, this is true only in the long term, in the same way as the correlation between business performance and stock price performance. For example, consider this: someone offers you $2 if a coin lands heads, while you will lose $1 if the coin lands tails (the coin is fair). You take this bet thrice, and the coin lands tails all three times. You end up $3 poorer. Did you make a bad decision?
- Decision quality determines the range of possible outcomes, whereas luck determines which one of the possible outcomes will materialize. You can think of this as a Punnett square in biology, where parental genotypes determine the possible genotypes for offspring, but luck determines which of the possible outcomes will occur.
- Counterfactual thinking, i.e., thinking about the other possible outcomes which did not occur, is crucial for making better decisions (this point is also made in the book 'The Psychology of Money'- one of my all-time favourite books).
- A pros and cons list is a decent starting point for evaluating choices. However, it does not consider probabilities of outcomes and the magnitude of payoffs, thus making it an inefficient tool.
- There is tremendous ambiguity involved in probabilistic terms like 'probably', 'real possibility', 'good chance' etc. It is a good idea to put a number to such terms, to avoid misinterpretations. Similarly, when someone tells you they are 'super bullish' on a stock, ask them how much of their portfolio they have invested in that stock. This will help you clarify exactly how bullish is 'super bullish'.
- Always think in terms of ranges- upper bound, lower bound and bulls-eye estimate. As the saying goes, it is better to be approximately right than to be precisely wrong.
- For making quick decisions, use two tests- a) is the outcome likely to have a large impact on my happiness in the short and long term? For example, what you eat for dinner today is unlikely to materially impact your happiness in the next week or month. In such cases, you can take quick decisions. b) is this a repeating choice? Sticking with the same example, you eat dinner every day, so this is a decision you make every day- in such a case, a bad outcome will not hurt much.
- Identify freerolls, i.e., a material asymmetry between probability-weighted upside and downside and bet big and quick on those rare opportunities. The keyword here is 'probability-weighted': a lottery ticket (with a $1M upside and $1 downside) is not a freeroll, although it may optically look like one.
- Conduct a premortem on your decisions, i.e., try to forecast yourself a year down the line and imagine that the outcome was adverse. What could be the possible reasons for the same? For example, imagine that one year from now, the Nifty 50 has delivered a positive 20% return* whereas your portfolio is down 10%. What could be the possible reasons for this to occur? Perhaps your investee companies are overvalued? Perhaps they have corporate governance issues? Thinking this way forces you to identify potential weaknesses and make appropriate changes to your portfolio, as and when required.
The book also has several exercises, which I would recommend a reader to attempt, either by writing down your answers or even mentally. Further, the book has notes and a checklist at the end of each chapter, making it easy to re-read the key concepts of the book.
Overall, it was a wonderful read! Anyone who liked 'Thinking, Fast and Slow' is likely to enjoy this book too. 'How To Decide' has secured a place for itself among my all-time favourite books!
10/10
*This is NOT a prediction.