Annie Duke received an NSF Fellowship to attend graduate school at the University of Pennsylvania to study cognitive psychology. Because she missed the job market one year due to a stomach ailment that put her in the hospital, she decided to try to make some money by playing poker until the next academic hiring season. This detour resulted in her acquiring 20 years of experience in the real-world behavioral laboratory known as professional poker. In 2004, she won her first World Series of Poker bracelet and that same year she won the $2 million winner-take-all WSOP Tournament of Champions. In 2010 she won the NBC National Heads-Up Poker Championship beating her mentor Erik Seidel in the final event. She is the author of Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts.
This is my 300th blog post. It is part of a streak of one blog post every weekend for that many weeks in a row. That continuous streak started in January of 2013, which seems like a long time ago. This post will be a little bit different in that I will put some links in body of the post instead of just in the End Notes. This is tricky since people may follow these links and sometimes to do not return to read the entire post. I am trusting that you will read the entire post before following the links this time.
Annie Duke is very articulate which allows me to spend more time than usual in this post just letting her make points. There is less of my usual commentary and more pointers to other material to keep the post from being too long.
- “There are exactly two things that determine how our lives turn out: the quality of our decisions and luck.” “There are elements of luck and skill in virtually any outcome.” “We can’t control luck.” “The world is a pretty random place.” “If making the same decision again would predictably result in the same outcome, or if changing the decision would predictably result in a different outcome, then the outcome following that decision was due to skill. If, however, an outcome occurs because of things that we can’t control (like the actions of others, the weather, or our genes), the result would be due to luck. If our decisions didn’t have much impact on the way things turned out, then luck would be the main influence.”
No one has done more thinking and writing the impact of luck on making decisions than Michael Mauboussin. He writes that luck has three core elements: 1) it operates on an individual or an organizational basis; 2) it can be positive or negative; and 3) it is reasonable to expect that a different outcome could have occurred. Mauboussin points out: “There’s a quick and easy way to test whether an activity involves skill: ask whether you can lose on purpose. In games of skill, it’s clear that you can lose intentionally, but when playing roulette or the lottery you can’t lose on purpose.” My blog post about Mauboussin’s ideas on luck is here.
- “Some things are unknown or unknowable.” “The influence of luck makes it impossible to predict exactly how things will turn out, and all the hidden information makes it even worse.” “Making better decisions starts with understanding this: uncertainty can work a lot of mischief.”
My blog post on Richard Zeckhauser is about the impact of the “unknown and unknowable” on making decisions. Zeckhauser believes: “Uncertainty, not risk, is the difficulty regularly before us. That is, we can identify the states of the world, but not their probabilities. There is no way that one can sensibly assign probabilities to the unknown states of the world.”
- “What good poker players and good decision-makers have in common is their comfort with the world being an uncertain and unpredictable place. They understand that they can almost never know exactly how something will turn out. They embrace that uncertainty and, instead of focusing on being sure, they try to figure out how unsure they are, making their best guess at the chances that different outcomes will occur. The accuracy of those guesses will depend on how much information they have and how experienced they are at making such guesses.”
My 299th blog post on Howard Marks is about thinking probabilistically when making decisions. I doubt that is a topic I have discussed more in course of writing this blog that the importance of thinking in terms of probability in making decisions. Marks says: “The future does not exist. It’s only a range of possibilities.” “The expected value from any activity is the product of the gains available from doing it right multiplied by the probability of doing it right, minus the potential cost of failing in the attempt multiplied by the probability of failing.”
- “The book title ‘Thinking in Bets’ really comes from the person who wins a bet is not the one who affirms their priors, it’s the person who has the most accurate model of the world.” “Every decision commits us to some course of action that, by definition, eliminates acting on other alternatives. Not placing a bet on something is, itself, a bet.” “When we think probabilistically, we are less likely to use adverse results alone as proof that we made a decision error, because we recognize the possibility that the decision might have been good but luck and/or incomplete information (and a sample size of one) intervened.” “By treating decisions as bets, poker players explicitly recognize that they are deciding on alternative futures, each with benefits and risks. They also recognize there are no simple answers.” “A decision about a stock (buy, don’t buy, sell, hold, not to mention esoteric investment options) involves a choice about the best use of financial resources. Incomplete information and factors outside of our control make all our investment choices uncertain. We evaluate what we can, figure out what we think will maximize our investment money, and execute. Deciding not to invest or not to sell a stock, likewise, is a bet.”
Duke argues in her book that framing decisions as “bets” forces a decision maker to think probabilistically. She believes this framing is helpful in reducing the risk that dysfunctional heuristics will interfere with a sound decision making process. I have written often on this topic. Most blog posts on Daniel Kahneman and Dan Airely are just two examples that come to mind quickly, as does my post on Charlie Munger’s famous talk on human misjudgment.
- “Improving decision quality is about increasing our chances of good outcomes, not guaranteeing them.” “Admitting that we don’t know has an undeservedly bad reputation. Of course, we want to encourage acquiring knowledge, but the first step is understanding what we don’t know.” “Once you acknowledge uncertainty it should make you information hungry. We can’t control luck. We can control how much information we have.” “Approaching decisions in a probabilistic way, getting help from people who offer different viewpoints, exercises to get ourselves to see decisions from other perspectives, learning the right lessons from outcomes — these are all habits of mind that will improve our decision quality.” “Building the most accurate model of the world which requires that you view your beliefs is in progress and once you view your beliefs is in progress, you can’t really be right or wrong anymore. They’re just provisional until the next upgrade.”
“Circle of competence” is a very important idea. The best and easiest way to lower a failure rate is to avoid investing in situations which you do not understand or do not have experience. The goal of an investor who follows a circle of competence approach should be to consistently avoid stupidity. It’s that simple. In my blog post on Warren Buffett I quote him as saying: “We are limited, of course, to businesses whose economic prospects we can evaluate. And that’s a serious limitation.” The most interesting investors are information hungry and relentlessly curious.
- “Instead of seeking opinions that confirm what you already believe, seek out those with which you disagree. Listen with an open mind” “What makes a decision great is not that it has a great outcome.” “The person who wins a bet is not the one who affirms their priors.” “The goal is to be accurate rather than be right about your prior views.” “A great decision is the result of a good process, and that process must include an attempt to accurately represent our own state of knowledge. That state of knowledge, in turn, is some variation of ‘I’m not sure.’” “The only real failure is to learn from it.” “The worst player at the table has something to teach you.”
Everyone can benefit from having wise colleagues who can help them make better decisions. Charlie Munger has said on this topic:
Everybody engaged in complicated work needs colleagues. Just the discipline of having to put your thoughts in order with somebody else is a very useful thing. We all benefit from the perspective of other people since we have lousy perspective on ourselves.
Even Einstein,” says Charlie Munger, “wouldn’t have been successful if there weren’t other people he didn’t talk to all the time. Total isolation does not work. You need interaction, putting your own thoughts into expression; you learn things just from doing it.
The best advice I ever got from Warren was to stop practicing law,” says Munger. “He thought it was all right as a hobby, but as a business it was pretty stupid.
As any semi-regular reader of this blog knows, I have written a lot on Charlie Munger (more than 20 total posts just on him are linked to below). One of these posts on Munger is about how he learns from failure. His view can perhaps best be summarized in this way: “I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.” Why have I written so many Charlie Munger posts and only one on Warren Buffett? It was Munger’s ideas that caused me to sell much of my technology stocks before the Internet bubble collapsed. His influence on the most important financial decision in my life makes me feel grateful. It is also the primary reason my I wrote my book on Munger.
- “There’s this word that we use in poker: ‘resulting.’ It’s a really important word. You can think about it as creating too tight a relationship between the quality of the outcome and the quality of the decision. You can’t use outcome quality as a perfect signal of decision quality, not with a small sample size anyway. I mean, certainly, if someone has gotten in 15 car accidents in the last year, I can certainly work backward from the outcome quality to their decision quality. But one accident doesn’t tell me much.” “You can improve the probability that you will have good outcomes by improving your decision-making, but that is not making your own luck. That is increasing the chances that you have a good outcome. You can’t guarantee that things will turn out well and even though you might have made decisions that increased the probability that you have a good outcome, you cannot guarantee it. You cannot make luck go your way. It’s this idea of incrementally increasing the chances that things go well for you and that hopefully, those things play out over time.” “You can improve the probability that you will have good outcomes by improving your decision-making, but that is not making your own luck. That is increasing the chances that you have a good outcome. You can’t guarantee that things will turn out well and even though you might have made decisions that increased the probability that you have a good outcome, you cannot guarantee it. You cannot make luck go your way. It’s this idea of incrementally increasing the chances that things go well for you and that hopefully, those things play out over time.”
Luck has an unappreciated impact on people’s lives since it is so easy to rationalize success. Munger has said about luck: “The people who get the outcomes that seem extraordinary are the people who have discipline, and intelligence and good virtue plus a hell of a lot of luck.” “I did not intend to get rich. I wanted to get independent. I just overshot.”
- “We are wired to protect our beliefs even when our goal is to truthseek.” “There’s a difference between sort of being humble in the face of the game that you’re playing and humble in the face of the opponents that you’re facing.” “We’re all arguing our case. That’s the thing. We all have beliefs that we think are true or false, right? We all make predictions about the future and we are really good at making a case for our stuff. And in fact, we kind of know that because we can see when other people are like clearly just like arguing their side and leaving data out and spinning the facts and putting a particular frame on it. So, here’s kind of the problem when you’re really statistically adapt to your very mentally agile is that we all want our beliefs to be true. We all want our predictions to be right. And so, we will argue in order to make our case. We’re kind of our own best PR agent and the smarter you are, the better you are at the spin.” “Hindsight bias is the tendency, after an outcome is known, to see the outcome as having been inevitable. When we say, ‘I should have known that would happen,’ or, ‘I should have seen it coming,’ we are succumbing to hindsight bias. Those beliefs develop from an overly tight connection between outcomes and decisions. That is typical of how we evaluate our past decisions.” “I know all this stuff [about dysfunctional heuristics], but I still do it all the time.”
In my blog post on poker I included this story I first heard from Mauboussin which illustrates what Duke is talking about just above:
“[A baseball executive] was in Las Vegas sitting next to a guy who has got a 17. So the dealer is asking for hits and everybody knows the standard in blackjack is that you sit on a 17. The guy asked for a hit. The dealer flips over 4, makes the man’s hand, right, and the dealer sort of smiles and says, “Nice hit, sir?” Well, you’re thinking nice hit if you’re the casino, because if that guy does that a hundred times, obviously the casino is going to take it the bulk of the time. But in that one particular instance: bad process, good outcome. If the process is the key thing that you focus on, and if you do it properly, over time the outcomes will ultimately take care of themselves. In the short run, however, randomness just takes over, and even a good process may lead to bad outcomes. And if that’s the case: You pick yourself up. You dust yourself off. You make sure you have capital to trade the next day, and you go back at it.”
One person who is a model for thinking for yourself is Richard Feynman. My post on him is here. He said once: “No idea is true just because someone says so. Test ideas by the evidence gained from observation and experiment! If a favorite idea fails a well-designed test, it’s wrong!”
- “The problem with using chess as a model for the kinds of decisions that we make in life is that chess is a very constrained problem, meaning there just isn’t a lot of uncertainty in it. There is a very little bit of luck and there’s no hidden information in the sense that you can see all the pieces sitting right in front of you, so I have access to your whole position. Now, there’s certain things I don’t have access to, like I don’t know what openings you’ve recently been studying, for example. As far as the pieces as they lay, I can see all of those. In terms of the luck element, there’s nobody rolling the dice and then if it comes up nine, I get to take your bishop off the board, so there’s almost no luck in that game. What that means is that it’s a very different problem than most of the kinds of problems that we have to tackle in life. Life is much more like poker where there is lots of hidden information, the cards are face-down and the relationship between your decision quality and the way that an outcome might turn out on a single try is actually quite loose.”
I have written often on this blog that some of the greatest investors like to play games. For example, Howard Marks likes backgammon. Buffett and Munger play bridge. Charlie Munger has said about one of his other favorite games:
“The teaching value of poker demonstrates that not all effective teaching occurs on a standard academic path.” “Part of what you must learn is how to handle mistakes and new facts that change the odds. Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand.” “Playing poker in the Army and as a young lawyer honed my business skills. What you have to learn is to fold early when the odds are against you, or if you have a big edge, back it heavily because you don’t get a big edge often. Opportunity comes, but it doesn’t come often, so seize it when it does come.” “And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time they don’t. It’s just that simple.”
- “Retirement saving is a discounting problem: People will take a discount to get something now instead of something more valuable in future. They will take $1 today instead of getting $2 down the line. People have to imagine themselves at the end of their careers, rather than the beginning.”
There are few topics that worry me more than this one. People have ingrained dysfunctional tendencies that may result in huge numbers of people who are elderly and poor since they can’t overcome this discounting problem. In many societies people try to solve this old age problem by having a lot of children who might take care of them when they are older and that creates even more negative societal spillovers.
What’s the nature of this problem? A new paper I provide a link to in the End Notes describes the issues involved:
“exponential-growth bias (EGB), is a perceptual bias whereby people underestimate exponential growth processes due to neglect of compound interest. This bias distorts individuals’ perceptions of their lifetime budget constraint: a person with EGB will underestimate the returns to saving and the costs of holding debt.
present bias (PB), is the tendency to overweight present consumption relative to future consumption in a dynamically-inconsistent way. This bias is qualitatively different from EGB in that it modifies the objective function rather than the perceived budget constraint, increasing the importance of immediate consumption at each point in time.”
On deferred gratification generally, Charlie Munger says it best:
“Great investing requires a lot of delayed gratification. It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”
“There are a lot of things where the only way to win is to work a long time.”
“I talked about patience. I have read Barron’s for fifty years. In fifty years I found one investment opportunity in Barron’s, out of which I made about $80 million with almost no risk. I took the $80 million and gave it to Li Lu, who turned it into $400 or $500 million. So, I have made $400 or $500 million from reading Barron’s for fifty years and finding one idea. Now, that doesn’t help you very much, does it? Well, I’m sorry, but that’s the way it really happened.”
“I lived all my life with people who were into deferred gratification. In fact, most of them will never have any fun. They just defer gratification all the way to end, that’s what we do. And it does cause you to get rich. So we’re going to have a lot of rich dead people.”
- “Venture capitalists spread their bets. They know that any single investment is likely to fail, but the basket of investments will likely win.” “You still need to be selective. Just doing stuff isn’t enough. You can’t just throw spaghetti against the wall. You need to think about each strand and make sure you are getting a payoff for the strand.” “VCs are vetting each of their bets to make sure the payoff is going to be big enough given what they know. That’s similar to what a poker player does.”
I enjoy writing about venture capital. My book A Dozen Lessons for Entrepreneurs reflects that interest. Part of my interest in venture capital comes from the time I spent learning from the Benchmark partners during the Internet bubble when I spent a lot of time in California. I learned more about business and investing during that period than any other time in my life. Fortunately, my understanding of the ideas of Charlie Munger meant that I was personally financially prepared for the collapse of the Internet bubble. But when it happened it still broke my heart since I was forced to turn my attention away from venture capital investing to learning other lessons about managing businesses through a severe downswing in the cycle.
- “If you want to get better at something try to teach it.”
I’m thinking about what I will do now that I have reached 300 blog posts. I appreciate the fact that you have read this far in this post, but understand that not many people do so. In my previous blog post, I quoted Howard Marks as saying that he writes primarily for himself. I would also write even if no one else read it. If you have something you have learned, my suggestion is that you try to find ways to teach it. I think you will enjoy it and you will be doing something that makes the world a better place. Munger advises:
“To make teaching endurable, it has to have enough wiseassery in it. And we do.” “We’ve done a lot of preaching [about investing] to not much effect.” “To the extent you’re working on it, you’re on the side of angels, but lots of luck.”
EGB and PB bias: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3249876