Excessive Self-Regard (Egocentricity)

Definitions

Egocentricity is not a good word to describe what I am going to say so I had to change the term for an excessive self-regard. You can define it as ”An excessive belief in your own choices, skills, personal characteristics, stuff, etc.”

An excessive belief in your choices and skills

Most people think they are better than average in things they do. For example, 90 per cent of the Swedish drivers thought they were better than average. It is easy to see it is not mathematically possible. Finding excuses like bad luck for failures, is one of the most usual ways of letting your ego work against you. Your ego can also produce big failures after lucky successes. Succeeding because of luck, instead of skill, can create overconfidence for future success in similar situations. This can lead you to reach for big payoffs by taking risks you cannot handle. It is better to lose by doing the right thing than to win by doing the wrong thing. First thing will lead to bigger successes in the future and the last thing bigger failures in the future. In the long run, fixing the wrong ways of getting results is more important than getting the right results.

Preferring people like you

You will probably prefer people like you. They may look like you, think about life like you, have a same name or some other things that resemble your characteristics. You may choose to be a customer for a salesman you resemble or have same hobbies, same type of family etc. Employers hire people who are like them. They think they can estimate their abilities better than actual track records can show. Bigger groups with similar people will succeed worse than diverse groups of people. The biggest catastrophe of this millennium, the real estate crash of 2008-2009 was caused by groups without enough diversity in opinions, risk-taking etc. When groups of people go too far in similarities of opinions, biggest catastrophes will come. Groupthink rules and big failures happen.

Loss aversion and Endowment effect

Many options in life have two sides. You can win or you can lose. You have to make decisions based on your ability to understand or take risks. Most people suffer more from losses than winning. For example, imagine a coin toss in which you can win 60$ if the result is heads, and you can lose 50$ if the result is tails. Would you take that bet? In more cases, people decide not to gamble. Imagine a situation where you have already lost 50$. And you want to win it back with a coin flip in which there is a possibility to lose 50$ more if the result is heads or a possibility to get your 50$ back if the result is tails. Would you take that bet? More people would take this bet than the first one.

These bets are forms of loss aversion. Some research suggests that people need to have twice as much gains than losses before they will take these bets. When you talk about a single bet, there can be some circumstances that can make avoiding loss the smartest decision, like not affording to lose any money. In the long run, you should take all these kind of bets as often as possible, when the losses are not crucial to your survival. There is also an endowment effect that says that you think the things you already have are more valuable to you than what you paid for them. For example, if you paid for a concert ticket for 100$, you will not sell it without getting much more money. If you ever go to a garage sale, it is probable that you will see that most prices are too much for you. Seller suffers from the endownment effect and keeps prices high.

Consistency and commitment bias

If you have made a choice or taken a stand, you will suffer from personal pressures to consistently follow the direction of the commitment. You will continue to behave consistently with these pressures. The biggest reasons are that you save energy and it is most often the smartest thing to do. The longer you continue, the harder it comes to change your behavior. Establishing good habits help you to use this tendency into your own advantage. Watch out for bad habits. You should change them before you have strengthened them. Moving consistently into wrong direction, will create wrong algorithms. And moving into wrong direction for too long will create a bad habit that is hard to get rid off. When it comes to commitments, the more effort you put, the more committed you will be.

There are other ways to make a stronger commitment. You should publish your commitment in some way. For example, you can put it on writing and give the commitment to the people you trust and admire. Written commitments require more work than the verbal ones. They will lead to more effort, and you will have better chance to live up to them. Watch out for all the public declarations, even the small ones, you are about to give. Be sure they work for your advantage. Saying yes too many times can lead you to problems with the so-called compliance practitioners like salesmen,, con-men, representatives of goodwill organizations, etc. They will probably try to lead you to wrong direction by asking really small commitments before the big ones.

Antidotes against excessive self-regard

There are different antidotes for different kinds of excessive self-regard. You have to understand that your track record is more important than your belief in your choices and skills. When you make a choice, you have to measure and check the end result. And believing the end result tells you more than your opinions. The other antidote is to seek the smartest possible experts to tell you the truth about your choices and skills. Do not believe a single opinion. These experts cannot have motivations to act with dishonesty. If the experts are not available, use your friends and relatives who are willing to tell you the truth no matter how much it will hurt. These people are hard to find. They are worth all the effort. Modern way is to publish your best ideas and choices and principles you have to make them. For example, create a website that is available for everybody´s feedback.

The best way for employer to avoid hiring people like him/her is to believe applicant´s past record more than face-to-face interviews. If you are a customer, thinking about buying something, you can choose a salesperson who is completely different than you are. For example, choose an old male if you are a young woman. You should also mostly focus on the product than giving any information about yourself. Similarity has a smaller effect on you this way. Antidotes of a loss aversion and an endowment effect are hard to find. The way you could approach loss aversion is to think what would happen in the long run if I chose this possibility instead of the other one? One antidote for endowment effect could be to not buy anything. The other way is to always seek an expert´s opinion of the true worth of your possession.

The best way to avoid being consistent in the bad way is to be consistent in a good way. Lots of good habits help you to get what you want in life. You should also alter your enviroment in a way that reduces available triggers for bad habits, decreases your contacts with compliance-practitioners and possibilities of saying yes to commitments that are no good for you. You should also challenge your best ideas and practices all the time. Always seek productive arguments against them. If you are not willing do it, find someone who is. You can even use your worst enemy if he can think clearly.

Sources:

Poor Charlie´s Almanack, Peter Kaufman
Thinking Fast and Slow, Daniel Kahneman
Influence, Robert Cialdini


-TT

Psychological tendencies (heuristics and biases)

Definitions

Psychological heuristics can be defined as ”Simple, efficient rules which people use to form judgments and make decisions.” Psychological biases can be defined as ”Systematic patterns of deviation from norm or rationality in judgment.” For the sake of keeping things simple, I will call heuristics and biases psychological tendencies

Your behavior is guided by the simple algorithms in your nerve cells

You will probably see yourself as a rational thinker who makes decisions after careful consideration. This is not an exact picture of reality. You have two sides, the emotional and the rational. Both sides need each other to work well. Most often they work the way they should. Sometimes, you are predictably irrational. When this happens, you are mostly using your emotional side. Your nerve cells have simple algorithms, that are guiding your behavior. These algorithms are simple instructions. They are either based on your genes or your experiences. Sometimes, you are manipulated by some people using these algorithms. Manipulation can be so subtle that you don´t even notice it. Subtle manipulations can have a compounding effect in which repetitive small changes create bigger results and irrationalities.

People have different reactions to different tendencies. They can be personal or cultural. Some people hate authorities and someone are infatuated in them. Asians are more interested in the collective good and people in Western countries are more individualists. You have to figure out yourself which tendencies have the biggest effect on you. A process of trial and error can be used. Gradual changes and reactions to them will eventually lead to right responses.

Tendencies are not best suited to modern environments

Environment changes fast compared to brains. Most tendencies have been developed through millennia. Emotions and instincts related to survival are the most common reasons for these tendencies. They save your energy. Especially, energy used by your brain. Their usefulness in modern environment is restricted. Most often, they lead you to the right direction, but sometimes they cause you misjudged decisions. Today, your survival is not at stake all the time. Tendencies that increased your chances of survival millenniums ago have more negative consequenses in modern environments. These tendencies lead to irrational decisions concerning on many other things than survival, for example, decisions about money.

You can also manipulate your own environment in a way that increases the usefulness of these tendencies. You can and you should help yourself to achieve success by using them to your own advantage. For example, you can create better habits by creating an environment in which there are many triggers that lead to good behavior. You can and you should also create an environment in which triggers for bad habits are unavailable or hard to detect. You cannot avoid all the negative effects in your life.

Experts have diagnosed more than hundred tendencies.

There are more than hundred different tendencies diagnosed by the experts in different branches of psychology. Most of them are just special cases. Learning all the special tendencies in certain cases is useless. There is a need to simplify things as far as possible. It is safe to say that understanding less than dozen tendencies and how they interact with each other is all you need to know about them. Most often, psychological research is concentrating on a single tendency. Most often, in real life situations, tendencies are not working alone. Thinking about a single tendency often leads to wrong conclusions. I have to say that, until now, it has been really hard to research many tendencies in the same time. As big data increases and artificial intelligence becomes smarter, it becomes easier to understand the effects of the combinations of tendencies. 

Many tendencies are the exact opposites. By understanding one, you understand the other. For example, liking and disliking tendencies can be put together. I have also tried to simplify and group many tendencies together. For example, egocentricity is consisted of loss aversion, endowment effect, confirmation and consistency biases, etc. Figuring out egocentricity helps you to understand all of them without remembering all of their names, definitions, or situations in which they have an effect on people. All this complexity becomes simpler and things start to make more sense. Here is the list of all the tendencies I will go through at some point. I have tried to put them in order, where the most important ones are first:

• Excessive self regard (egocentricity)
• Availability 
• Associations
• Social proof
• Scarcity/Abundance
• Authority misinfluence
• Contrast misreaction

All these tendencies can and will be used against you, either you do it yourself, or someone else does it. You should use them only to your own and common good. Using them for others will eventually backfire. Even the awareness of these tendencies, diminishes their negative effects. And hopefully will create positive influence.

Sources:

The Art of Thinking Clearly, Rolf Dobelli

Thinking Fast and Slow, Daniel Kahneman

Poor Charlie´s Almanack, Peter Kaufman

Have a nice end of the week

-TT

Opportunity costs

Definitions

Opportunity costs can be defined as ”The loss of other alternatives when other alternative is chosen.” Or as ”The value of the choice of a best alternative cost while making a decision.”

Some opportunity costs are easier to understand than others

All the things you do have opportunity costs. You can´t have everything. When you choose something, other possibilities are not available in the present moment. For example, if you want to work, you cannot watch TV. You always need to compare the alternatives with each other. Opportunity costs can be different than the cost of acquiring things. For example, when you get something for free, your loss comes from lost time, space, effort, etc.

Counting or approximating the cost can be simple or extremely hard. Easy choices like choosing a brand label which costs 1.5$ or a similar product that costs 1$, make counting opportunity costs easy. The opportunity cost of choosing a brand label is 1.5$-1$=0.50$. Simple calculations about opportunity costs are useful tools. When complexity arises, opportunity costs are harder to calculate. For example, when you think about working over time or spending your time home with your family, opportunity costs are very hard to calculate. Calculations can become harder, when the options are plentiful or each of the two options have several factors that change or are harder to put any value on them. For example, choosing a laptop from different models, brands, and characteristics. In addition to them, you have to consider all the different prices.

”If cow had wheels, it would be delivering your milk”

Most opportunity costs have ifs. You have to consider the uncertainty, when you are trying to figure out them. If you are using statistics and/or probabilities, to calculate opportunity costs, you have to understand what you are doing. You cannot rely on averages, when they do not matter. For example, expected payoffs are not always the same as averages. For example, stock indices can give you real 7% of annual return, on average. Comparing this number with saving money and calculating opportunity costs gives you wrong results, when stocks are very expensive or very cheap.

Most often, there are some uncertainty in calculations. And when there is uncertainty, you have to understand the need for margin of safety. Ifs create errors. These errors can be way larger than you think. This is really important, when you are thinking about changes for things that work at least on average. The other opportunity has to be much better than a previous thing. A famous investor John M. Templeton talked about 50% better opportunity before changing an investment vehicle for a better one. I am not saying that you should do the same. 50% better is just an example about investing and about one person. You should figure out your own margins in different situations. They can be larger than you think.

Some instructions for calculations

Keep things simple. The more options you use, the harder the calculations become. You should leave the least probable options away from your calculations. In economics, you only calculate the opportunity costs compared to the second best alternative. This should work with simple options considering money. I wouldn´t use only the second best option all the time, but you figure out what is best for you. You also shouldn´t compare apples with oranges. You can´t calculate or estimate opportunity costs of two totally different options. If you think that you cannot calculate or estimate opportunity costs within fairly easy, forget them, especially, when you are talking about small decisions. Calculating opportunity costs have opportunity costs too.

Sources:

Poor Charlie´s Almanack, Peter Kaufman

Risks

Definitions

A risk can be defined as ”A potential of gaining or losing something of value.” or ”An exposure to the chance of injury or loss.”

Personal risks

First I would like to say that risks affect on you in many different levels. For example, they affect on you through corporations, nations and global events like wars. I will keep things in personal level. Humans are very good in understanding risks related to their survival. Especially, when their intuitive decision-making systems are on. You can avoid an imminent threat to your survival without even noticing it. For example, changing your direction from the normal route, because of something is not feeling right. Survival in these cases means not hurting yourself physically in an imminent danger. You are not good in avoiding long-term risks. Modern world has less imminent threats than your brain thinks. This creates many problems that even the risk management experts do not understand.

You have many personal risks other than risks of physiological harm. Financial risk is maybe the most common risk you think about. Losing your job, or inability to pay your debt can cause you harm. You may lose your reputation if you do something really stupid or someone spreads rumours about you. You also have a risk of not being able to adapt to the changing world. Doing what you have always done before is your path of least resistance. Changing things is hard, even when it is necessary. People are also increasing their technology risks, because their dependence on technology is rising. Personal risks can compound in a long-term. Taking small, but unnecessary risks without suffering the consequences fast may lead to severe problems later on. For example, eating crappy food may not cause you any harm for decades, until one day you get a heart attack without any warnings.

Risk Management

Risk management is about probabilities. You need to understand them to understand risk. Repeatable events with fixed probabilities are easier to understand. For example, risks at the roulette table and lottery are fairly easily quantifiable. When you cannot calculate a probability of something happening, you cannot really understand risks. Uncertainty is not well understood. Managing risks without understanding power laws is one of the most common causes of financial destruction for institutions and in a personal level. The other common cause is not understanding complex systems and the second order effects in them.

You have to consider your risk appetite too. Some people cannot sleep well with moderate risks in their lives and some people cannot sleep well without them. Risks are not all bad things. Progress comes from taking risks. Some of them are managed and some of them are not. Humans have developed as a race by avoiding risks concerning on survival. Risk-seeking is about functioning against your basic instincts. It is hard, but many times worth all the effort. When you understand the risks you are taking, it is easier to get better results. You have to ask yourself some questions to understand risks better:

• What are the consequences of not doing it? What will it cost you? What are the unwanted outcomes that can come true? How will you react if they happen to you?
• What are the positive consequences? What will you benefit? How will you react? How do you feel about the outcoming benefits now?

Risks can also be quantified in terms of impact of their consequences. You should use a simple scale in how you want to rate the impact of the risks. Make it reasonable. For example, you can use a three-level scale of impact for risks. Risks with high, medium or low impact. Think about high risks all the time. Risks with medium impact are not that important, but you should check them regularly. Low risks are not that relevant. You should still check them occasionally. You should also remember that low and medium impact risks can become high risks through compounding. In this case, it means taking many small risks many times.

Asymmetric risk

There are two kinds of asymmetric risk. Good ones and the bad ones. An asymmetric risk means that the reward is a lot bigger than the risk taken, or the reward is a lot smaller than the risk taken. In other words, the expected payoff is high or low, depending on the risk taken. Nobody wants to take an asymmetric risk where the expected payoff is crappy. Most often, this happens because the risk taker do not understand what he/she is doing. This happens to the most respected experts too. Especially, financial market participants do not understand risks. One reason is that they haven´t noticed the power laws in the markets or understand them. Many assumptions about the returns in the financial markets are made by thinking through a normal distribution. The problem is that returns in financial markets do not really realize through them. Most of the profits are made with a small number of stocks or during the small number of days, etc. In other words, extreme outcomes in financial markets have higher probabilities than using normal distribution tells you.

It is easy to make a statement that you should avoid all the asymmetric risks, where the downside is enormous compared to the expected payoff. For example, not going to see a doctor, when you have a severe chest pain. Not going to a doctor can cause a death and going to the doctor can save you. You can also take lots of asymmetric risks where the probabilities are against you. When expected payoff is high, you need smaller amounts of successes. This doesn´t mean that all the risks come true and payoff is always high. You should be ready for many losses with these kinds of risks. Overall, the expected payoff will be good in the long run.

Sources:

Smart -> Risk, Andrew Holmes
Risky Strategy, Jamie MacAlister
Fooled by Randomness, Nassim Taleb

-TT