Risk Savvy: How to Make Good Decisions

by Gerd Gigerenzer

The essence of the theory is captured by an insight attributed to Albert Einstein: Make everything as simple as possible, but not simpler. How far we go in simplifying depends on three features. First, the more uncertainty, the more we should make it simple. The less uncertainty, the more complex it should be. The stock market is highly uncertain in the sense that it is extremely unpredictable. That speaks for a simple method like 1/N. Second, the more alternatives, the more we should simplify; the fewer, the more complex it can be. The reason is that complex methods need to estimate risk factors, and more alternatives mean that more factors need to be estimated, which leads to more estimation errors being made. In contrast, 1/N is not affected by more alternatives because it does not need to make estimates from past data. Finally, the more past data there are, the more beneficial for the complex methods.