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Here's a Better Way to Deal With Life's Risks
The cost or payoff
The cost or payoff is not always clear.
For example, people feel more pain from the loss of a dollar than pleasure from a dollar gained. It is called loss aversion.
The prospect theory combines the ideas of loss aversion and over- and under-weighing the odds. It helps to calculate the real expected value.
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Expected value
We all spend time making decisions with some risk involved. We look at each situation and consider the likelihood that something will happen as well as if it would be worth it.
For example, whether to sprint across the street when the sign says “don’t walk.”
Expected value is then the odds of something happening multiplied by the cost of the expected value of the situation.
Calculating the odds
Part of the expected value is estimating the chance or probability of the situation.
Many people have poor judgement calculating real probabilities. They overstate the chance of rare events and underestimate the possibility of common events.
For example, many people don't like to fly on planes because they are scared they might be in a crash, yet the actual chance is close to zero.
The cost or payoff
The cost or payoff is not always clear.
For example, people feel more pain from the loss of a dollar than pleasure from a dollar gained. It is called loss aversion.
The prospect theory combines the ideas of loss aversion and over- and under-weighing the odds. It helps to calculate the real expected value.
A risky world
Risk is part of our lives and cannot always be avoided. We have to cross streets or drive in cars.
When we are faced with a risky situation, we can make a better choice when we consider the odds as well as the payoff.
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The sunk cost fallacy
It plays on this tendency of ours to emphasize loss over gain.
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A choice architect
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Intuitive and reflective thinking
- Intuitive and automatic: This kind of thinking is quick and feels instinctive. You duck when a ball is thrown at you unexpectedly.
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Anchoring Bias
A common occurrence of heuristics in which we use an initial starting point as an anchor that is then adjusted to yield a final estimate or value.
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Being Too Optimistic
People who are told that the risk of something bad happening is lower than they expected, tend to adjust their predictions to match the new information. But they ignore the new information when the risk is higher.
Part of this overly optimistic outlook stems from our natural tendency to believe that bad things happen to other people, but not to us.
You Often Make Poor Comparisons
Sometimes we make poor comparisons or the compared items are not representative or equal.
We often decide based on rapid comparisons without really thinking about our options. In order to avoid bad decisions, relying on logic and thoughtful examination of the options can sometimes be more important than relying on your immediate "gut reaction."
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