Investment Odds - A Different Way of Thinking
We might assume there's a method of thinking -- we'll call
it rational thought -- which is used by most intelligent or wise
people, and that it's the way we should all think to get best
results. It makes for a nice theory, and there clearly are more
and less rational people. But even if we were to identify a specific
process of "right thought," the most intelligent person
could not use it consistently. In practice we don't have enough
time, so we think and make decisions based on all sorts of rapid
and less-than-conscious processes in our heads.
For example, we use heuristics or "rules of thumb"
that let us quickly size up a situation or judge the validity
of a proposition. This process is also called intuition, an educated
guess, or common sense. The rules may be chosen, as when a man
decides to never throw the first punch, and consciously remembers
that rule when the time comes. But most of the time there are
a dozen little guidelines that are unconscious but very real,
as when an extreme skeptic automatically dismisses anything called
"spiritual," or any remedies for illness that are based
on anecdotal evidence.
We need this quick and automatic thinking process, even if
it isn't perfect. We can't rationally analyze every decision
from what to order at the coffee shop to exactly what information
to share or withhold from each person we deal with. Even thinking
about who to vote for, or whether our assumption that we should
be good to others is true, could eat up too much time if we tried
to perfectly analyze every aspect. Life moves on, and we don't
have the luxury of spending large chunks of it thinking about
any one part of it.
But although we develop a particular way of thinking (or ways)
largely unconsciously, that doesn't mean we can't do it more
consciously. In fact, we can develop habits of mind based on
"rules" chosen specifically to give us better results.
As an example, I'm going to explain how good poker players understand
and think in terms of "investment odds," and why that
process might be useful in everyday life.
A poker player is dealt four hearts. He can draw a card if
he "calls" the last bet. The probability of drawing
a heart to complete his flush is about 19% (.2). He figures that
if he draws the heart the probability of winning the hand is
90% (.9), and close to 0 if he doesn't get the heart. The probability
of his winning is found by multiplying the probability of drawing
the heart times that of winning if he draws it, which
gives him an 17% chance of winning (.2 x .19 = .171). So, with
roughly a 1 in 6 chance of winning, should he continue?
Ah, but we don't have enough information. Whether he should
bet also depends on how much he'll have to bet from that point
forward and how much he will make if he wins. The exact amount
that he'll have to bet and that will be in the pot is an educated
guess based on his knowledge of the game and the other players,
but based on his best guesses the potential win has to justify
the risk, which is what investment odds are all about. The formula
(which ignores what he has already invested, since this is irrelevant
at the point of deciding whether to add more):
Multiply the projected pot size by the probability of
winning and divide the result by the total of projected bets.
If the result is higher than 1, it's a good investment.
So if he expects that there will be $300 in the pot at the
end, and that he'll have to bet a total of $50 more, we get:
($300 x .17)/$50 = 1.02, which means this is just barely a good
Now Throw Away the Math
Yes, some poker players do the math that carefully, but the
good news is that for thinking in general the basic process is
more important than one's preciseness with the math (and preciseness
is impossible in most situations). The life lesson here, in case
you don't see it in the math, is that it isn't just about the
odds of success and the value things risked (love, time, money,
respects), but also about the balance between the probabilities
and the profits.
Should a single man risk saying hello to a pretty woman he
would like to know? Hmm... He might have a one in twenty chance
of "winning the pot," (getting to know her) but the
"bet" which he risks (saying hello) is very small,
so yes, the investment odds seem to be better than one. To see
it from another perspective, if he wanted to befriend a pretty
woman is it worth saying hello to twenty of them? Forty? Sixty?
Each is a small bet for a possibly big reward.
What about investing $25,000 to open a small restaurant, knowing
that (based on the statistics) there is only a 20% chance of
succeeding? Well, if the average success (over the years of ownership)
means making $500,000 more than a job would have paid, the answer
is clear (investment odds of 4 -- a screamingly good bet). By
the way, most successful entrepreneurs fail several times before
achieving lasting success, and this little demonstration of investment
odds, when contrasted with the advice of the many naysayers in
our lives, suggests we are too often scared off from good bets
just because losses are more common than wins. We don't see that
the big payoff is essentially bought by all those lost bets.
To train yourself in using investment odds as a way of thinking,
you look at the potential profit (in dollars,
security, pleasure, personal development) multiplied by the rough
probability of success, and determine from that if the size of
the bet (dollars, time effort, anguish) is justified.
This works in areas of life that are not as quantifiable too.
For example, should you believe what you read in a newspaper?
It is quick and useful to believe movie schedules, because experience
says they are almost always accurate and you lose little when
they fail. What about government economic forecasts reported
in the news? The potential win multiplied by the small odds of
success suggests that you better not bet much on them.
If someone tells me cows have five stomachs and I choose to
believe it I "win" a fun bit of trivia to share by
"betting" on the probability of this being true. What
do I lose (how much am I betting) if it's incorrect? Not much
if I do no more than share this "fact" with friends.
If, on the other hand, I'm writing a book on animals and my credibility
is at stake, I might want to verify this using other sources.
(By the way, I think cows have one stomach with four digestive
compartments -- but don't quote me on that.)
This may all seem to be common sense, but how often do we
over-invest our time in analyzing something for which -- if we
arrive at a different understanding -- we will derive very little
profit. Time is a valuable investment. And how often do we think
something is too risky when all we will lose is small amounts
of money and bits of time for a reasonable chance to gain a lot
of money (which buys time back if used correctly). Our "common
sense" is common, but better sense -- a better way of thinking
-- is not. It is cultivated by only a few.
To cultivate a better mind, practice a new and useful way
of thinking until its habitual, and then train yourself in yet
another good one. I'll have more of them in the future on this
website and in The Mind Power Report.