Risk Savvy: How to Make Good Decisions

by Gerd Gigerenzer

Finally, the more past data there are, the more beneficial for the complex methods. That is why the Markowitz calculations pay off with 500 years of stock data, as described above.

Thus, the more complex the method, the more factors need to be estimated, and the higher the amount of error due to variance. 1/N will always give the same stable recommendation, meaning that it doesn’t use any investment data from the past. For that reason, it doesn’t suffer from any variance. If the amount of data is very large, such as for five hundred years, the instability is reduced so much that complexity finally pays.

My research with managers suggests that the higher up they are in the hierarchy, the greater their reliance on gut feelings. Yet most said that when they have to justify decisions toward third parties, they hide their intuition and look for reasons after the fact.

Defensive decision making. Here, the strategy is to abandon the best option because it cannot be justified if something goes wrong and to favor a second- or third-best option.

The challenge for large companies is to better align the interests of their managers with those of the company, similar to how the interests of a family member are naturally aligned with those of the family business.

Companies could easily break through the taboo and calculate how much revenue they lose through a defensive culture.

A first measure would be to replace this survey with only two questions: How often do you make defensive decisions? And what do you think could be done to change this? That could be a start for designing a new corporate culture.

Leadership lies in the match between person and environment, which is why there is no single personality that would be a successful leader at all historical times and for all problems to solve.

If you are having difficulties hearing your inner voice, there is a much faster method: Just throw a coin. While it is spinning, you will likely feel which side should not come up. That’s your inner voice.

The ethical turmoil arising from genetic screening has attracted much attention. What’s not in the spotlight is that most doctors and patients will not understand the results of this both fascinating and controversial technology. If most doctors already misunderstand the chance of Down syndrome after a positive test, what can we expect when they evaluate the results of hundreds of tests?

I pointed out the widespread lack of risk literacy among patients and doctors; the routine misinformation in health brochures, ads, and other media; and the disturbing fact that medical schools still don’t teach their students how to understand health statistics.

Physicians don’t do the best for their patients because they: 1. practice defensive medicine (Self-defense), 2. do not understand health statistics (Innumeracy), or 3. pursue profit instead of virtue (Conflicts of interest).

How effective is this fast examination? A review of thirty-two studies showed that the ankle rules correctly detected fractures in more than 98 percent of all cases. It is highly successful in avoiding unnecessary radiation for patients.

An icon box brings transparency into health care. It can be used to communicate facts about screening, drugs, or any other treatment. The alternative treatments are placed directly next to each other in columns and both benefits and harms are shown. Most important, no misleading statistics such as survival rates and relative risks are allowed to enter the box.

Out of every one thousand women who did not participate in screening, about five died of breast cancer, while this number was four for those who participated. In statistical terms that is an absolute risk reduction of one in one thousand.22 But if you find this information in a newspaper or brochure, it is almost always presented as a “20 percent risk reduction” or more.

Fact boxes improve consumers’ knowledge of benefits and side effects, and result in better choices of drugs. They can also fight the daily barrage of medical news and advertisements faced by both doctors and patients.

For those who already smoke, there is also good news: If you stop smoking before age thirty, you can expect to fully regain the ten years of life otherwise lost, and stopping at age forty, fifty, and sixty, can regain nine, six, and three years, respectively.

In 1988 a first international regulation was crafted to regulate the capital a bank needs so that it is unlikely to default, known as the Basel Accord (or Basel I).3 This agreement was 30 pages long and the calculations could be done with paper and pen. It was questioned as being too simple and, based on an amendment from 1996, was revised in 2004 to something more magnificent, Basel II. With a great deal of added detail and new complex risk models, Basel II was 347 pages long. A few years after the creation of this masterpiece tailored to make the world safer, the financial crisis of 2008 broke out. The reaction was to weave an even more complex regulation, Basel III, which came to 616 pages. Whereas Basel I was translated into 18 pages of primary legislation in the United States, Basel III required more than 1,000 pages. I have asked central bank regulators: Who understands the consequences of Basel III? Their unanimous answer was probably not a soul.

The simple leverage rule would have likely saved billions of dollars lost in the financial crisis. For the future, it could create a strong safety net. Canadian banks survived the credit crunch relatively well because they were restrained by leverage ratios and had tougher lending requirements.

Last but not least, the dangerous long-term effect of spreading worst-case scenarios is that people will become cynical. When it’s a real emergency and antivirals and vaccinations might actually be needed, people’s trust in governments and in the WHO will have eroded so deeply that too few will bother to listen and get vaccinated.

The question is not whether the digital media will change our mental lives; they do. The question is how.

Hard paternalism, like antismoking legislation, coerces people into behaving a particular way and can be morally defended as long as it protects people from being hurt by others. Soft paternalism, such as automatically enrolling people into organ donation programs unless they opt out, nudges people into behaving a particular way.