Life is a little easier if you expect a certain percentage of it to go wrong no matter how hard you try.
Smart people screw up.
Good people have bad days.
Nice people lose their temper.
Pablo Escobar expected 10% of the cash he stored in warehouses to be eaten by rats or spoiled by mold. That was if everything went well.
Some downsides are unavoidable. You can push back, but they’ll never die. They’re part of life, and you might as well learn to accept them than pretend perfection exists.
Three in particular get in the way when thinking about risk.
1. It’s impossible to think about risk and opportunity without a reference point. And your reference point is at best incomplete if not totally wrong.
How risky do you think Covid-19 is? What should we do about it? What happens next?
No one can answer those without acknowledging what Covid-19 looks like in the eyes of different people.
An 80-year-old with asthma doesn’t think about its risks the same way a healthy 20 year old does.
A parent with young kids doesn’t think about working from home like a single person does.
A restaurant owner doesn’t think about economic opportunity like a software engineer does.
So people come to vastly different answers about Covid’s future – not because one is more right than the other, but because they’re thinking about the same problem with different reference points.
Everything we think about risk and opportunity is colored by our own unique situation and personal experience. I do it, you do it. It’s unavoidable. All risk and opportunity has to be measured against a set of baseline expectations. But since different people who’ve experienced different things and want different outcomes have different expectations, two people thinking about the same problem come to different conclusions. Both expect their conclusions to be right. Both are mystified when they’re often wrong.
You can try to be open-minded. But the world you see through your own eyes will always make more sense than the one you try to understand through others’. So we all wander around with a view of risk shaped by narrow experiences but applied to the broad world.
“Nothing can be done without preconceived ideas,” Sherlock Holmes said. I wish there was a way around this, but there’s not. Humility is the only antidote.
It’s an acceptable flaw.
2. Long-term thinking is hard to implement because the long run is a collection of short runs that have to be managed, marketed, and used as information to gauge whether a long-term reward still exists.
Imagine you’re a fund manager whose portfolio is down 30% one year. Then 10% the next year. And the next.
The fund manager could tell its investors, “Our investments are just temporarily out of favor. Over the long run they’re still going to outperform.”
And let’s assume that the fund manager is* right *about that.
The fund’s investors will still leave. Nine times out of ten, poof, they’re gone.
The fund manager is forced to close the fund, and the long term isn’t achieved because the short term wasn’t survived.
Long-term thinking looks easy in a spreadsheet. You can look at a long stretch of history and say, “If you just put up with a few lousy years you went on to capture excellent returns.”
That’s good thinking. It’s right thinking.
But the real world doesn’t play out in spreadsheets.
It plays out in quarterly letters, where you have to convince investors that poor performance will be temporary vs. a signal that you don’t know what you’re doing.
It plays out at the dinner table, where you have to convince a spouse that your net worth has plunged but, don’t worry, it’s all part of the plan.
It plays out in your own head, when you start to wonder whether your poor performance means you missed something, second-guessing your own skill.
Something can be as impractical as it is right. Long-term thinking often falls into that bucket – especially when it’s interpreted as a complete disregard of the short run, where critical decisions are made.
Short-term thinking is the root of most of our problems in business, investing, and politics. But I get why it happens. It has to happen. Short-term thinking can be the only way you’ll survive long enough to experience long-term results. It’s an acceptable flaw.
3. Underestimating the odds of change because an honest assessment of how unknown the future is would make most people refuse to get out of bed every morning.
Most of us are at least a little overconfident because of two truths:
No one knows what the future will look like.
You can’t make decisions unless you think you know what the future will look like.
We can poke fun at how inaccurate business and investing forecasts are. And we should. But I get why they happen. I get why they’re so persistent despite their track record. To rid yourself of the idea that the future is knowable is to admit that your decisions might be futile. It can feel like you’re fighting an opponent five times your size, which might be enough to say, “Why even try?” Nothing would get done in the world if people were only driven by the accurate probability of their future success.
Smart people think probabilistically about their chances. But even then, there’s widespread denial. If you know there’s an 80% chance your endeavor will fail, the majority of people will assume they will end up in the fortunate 20%.
Daniel Kahneman often asks business leaders, “To what extent will the outcome of your effort depend on what you do in your firm?” “The answer has never been less than 80%,” he says. They’re aware of the actions they’re taking, and to remain optimistic they have to assume those actions correlate with results. “They know less about their competitors and therefore find it natural to imagine a future in which the competition plays little part,” Kahneman says. Moving forward with a degree of blissful unawareness.
A little blindness, a little over-optimism, and a little denial is one of the economy’s most potent fuels.
It’s a flaw, but the alternative is worse. So it’s an acceptable one.