Making smart decisions in uncertain times
Every individual or organization has to take innumerable decisions on daily basis. When you are stuck in a choice between various alternatives then you have to make decisions. It is an indispensable part of our lives. Judgement of the process, by which one can choose between a numbers of alternative courses of action for the purpose of achieving goals is called decision making. This seems to be quite simple but one thing which we must remember is that, “Every decision has consequences”. The word ‘decide’ means to come to a conclusion or resolution. Thus every decision is a choice which a person makes based on his conclusion in a particular situation. Managerial decision making is synonymous with the whole process of management. It decides what should be done? How should be done? When and by whom should be done? There are many mental models explained in the article which helps in making decisions smartly.
Occam’s razor
Occam’s razor pronounced as Ockham’s razor is a mental model which says that always pick simpler solutions, since they are more likely to be correct than complex ones. This principle gives precedence to simplicity: of two competing theories, the simpler explanation of an entity is to be preferred. The principle is also expressed as “Entities are not to be multiplied beyond necessity.” The question must arise in your mind, why? In the history of philosophy, there were many attempts to justify this kind of reasoning. Prior to the 20th century it was believed that nature is itself simple. Therefore simple hypothesis get closer to the truth. Thomas Aquinas wrote that “Nature does not employ two instruments where one suffices.”
Perhaps the most well known instances of such a justification can be found in Copernicus’ rejection of Ptolemy’s geocentric model of the solar system, which was quite complex model in favor of a simpler model. Copernicus adopted Plato’s conception of celestial bodies as being perfect and thereby they would have to display perfect and simple kind of motion. One that is not found in this chaotic ptolemy’s geocentric model. We therefore can say that one of his reasons for developing an alternative model of the solar system was asthetic. Although it was by no means it’s the only reason. Since then, philosophers presented justifications for Occam’s razor that we might find more convincing, one being a direct result of basic probability theory. By definition, all assumptions introduce possibilities for error; if an assumption does not improve the accuracy of a theory, its only effect is to increase the probability that the overall theory is wrong.
Another justification for Occam’s razor resets on the observation that if we manage to simplify theoretical models in science, they get better at predicting future events. Simplicity, in this view, is a counterweight or counterbalance for the problem of overfitting our theory to a particular set of data. If we manage to deduce a simpler version of the theory, we can get rid of all the statistical noise in our experiments. Also simpler versions capture the underlying structure of the world better. Thus occam’s razor continues to be an effective method of reasoning both in science and everyday life.
Circle of competence
Circle of competence is a mental model developed by Warren Buffett and Charlie Munger. This model suggests focusing on area’s you know best. Everyone has a particular area which they are best in and have knowledge based on experience or learning. This is their strong side, an area where they can beat others. This is thus there circle of competence. Buffett summarized this concept as, “Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital.” In Munger words “You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.” According to these statements we should honestly define the areas we do know and stick to them. Thus what we know is our circle of competence.
For example let’s say that you work in the banking sector. Your understanding of the way the financial industry works will be based on your experience which will be stronger than someone who researches and tries to read about it online. Hence, when you invest in the financial sector, you are likely to make better decisions as opposed to someone from the textile industry who has read some articles about the sector online. Hence your circle of competence is financial sector in this aspect.
Base rate fallacy
When given both individuating information, which is specific to a certain person or event, and base rate information, which is objective, statistical data, we tend to give the specific information and dismiss the base rate information entirely. The base rate fallacy, or base rate neglect, is the term for this.
There are multiple factors that contribute to the occurrence of the base rate fallacy. One is the representativeness heuristic, which asserts that how representative an event or object is of its category effects our probability estimates with minimal concern for base rates. Another factor is relevance, which implies that humans regard individual information to be more important than general information, and hence prioritise individuating information above generic information.
For Example- Participants in a study were asked how much out of the five dollars they were given would they donate to a given charity. They were asked to make the same prediction about their average peer. Next, they were presented with the actual donations of 13 other donors and given the chance to adjust their predictions. They adjusted their predictions of their peers to match the base rate information but did not change their predictions for themselves. When we have access to individuating information, we assign it greater value than base rate information, which is why their ratings of themselves stayed the same. However, participants did not have access to individuating information about their peers and therefore relied on base rate information instead.
