personal-finance – Parts Per Billion

Risk and Rationality in Uncertainty

We have many philosophical ideas about how money is not everything in life but deep down, everyone knows how money constitutes to a bigger portion of who we are. Although money can’t buy everything, the unexplainable value it holds behind presence of almost everything in our lives will never go unnoticed. We know that this importance of money/ resources/ assets is highly dependent on how much of those we have right now and how much of those may get lost in an uncertain event. This perception of value drives our decision making in risky situations. The Expected Utility Theory (EUT) in economics deals with the modelling of such scenarios. The mathematical formalization of the perception of wealth and our risk profile is facilitated by this fundamental theory. EUT lies at the foundation of actuarial science/ insurance, financial risk management, decision making under budget restrictions, asset management, and investment management.

EXPECTED UTILITY THEORY

We live in an uncertain world. Timing events where too many interactions are happening could be risky especially when it comes to money or the basic resources for sustenance. In crisis situations, our survival instincts have always kicked in to ensure preservation of life and the resources required to ensure its longevity. They need not to be always rational, they are just meant to save life somehow, that is why most of the acts of survival seem extraordinary. Interesting thing to understand here is that when such extraordinary survival instincts kick in as a mass effect the whole mass effect becomes irrational, unexplainable, incoherent. There is no sane explanation to justify these mass events. When such events badly affect the resources responsible for basic life of every being, it can be catastrophic. Huge sudden falls in stock market are good indicators of such disasters, crises. Insurance on the other hand could prepare person to handle the disasters in a preventive way. Stock market and insurance are one of the best examples to understand how people assess risk and maintain/ reject rationality while making important decisions. We will see what formal ideas from economics lie behind these events of uncertainty.

Expected Utility Theory (EUT) in Economics

Expected utility theory lays the foundation of how a rational person would make decision in an uncertainty where valuable resources like money are involved. The whole idea is based on the quantification of that uncertainty and connecting that uncertainty with the individual gains from individual uncertain event. Expected utility also creates a formal structure of how person perceives risk in given scenario. This helps to quantify the value generated from any economic event.

Origin – St. Petersburg Paradox

Daniel Bernoulli is credited to establish the expected utility theory which is one of the foundations of economics. The theory emerged from the St. Petersburg Paradox which goes like this:

You have $2 and we toss a coin. Heads, the amount you have now is doubled and tails then the game stops and you leave with whatever amount you have right now. The game continues till its always heads in series and stops when the coin shows tails.

The question is how much will you be willing to pay to enter this bet?

The probability of heads and tails is 50-50% which is ½ . If it is a series of heads (heads followed by heads) then the events are dependent on each other, so the probability of this event is intertwined with the probability of the previous one. If there happens a game where you start with $2 and every time heads comes, and the money goes on doubling the equation of gain would be:

As this math goes, a person should pay infinite amount as he will be gaining infinite amount from such game. ‘E’ value here is identified as expected value. Even if one such possible game would happen in reality, people won’t pay infinite amount in reality to enter this bet.

Bernoulli resolved this paradox by creating the concept of Expected utility. People will pay not what actual value it delivers (as in the $s of money); they will pay according to how actually it will be useful to them, ‘utilizable’ to them – that is where the utility and thus expected utility comes in picture.

Expected utility is calculated by the amount one would gain and the chances of gaining that amount. The expected utility thus is sum of all the gains connected with the probabilities of gaining them.

Daniel Bernoulli
The determination of the value of an item must not be based on its price, but rather on the utility it yields.

1^st Tenet of EUT: Expectation

The overall utility of a prospect, is the expected utility of its outcomes.

In very simple words, for a given scenario you will weigh the chances of its constituent events and connect them with their respective gains. The sum of the all connections of each gain with their chance of realization is the usefulness – utility of that scenario.

Mathematically,

Expectation:

In our example we need to assume something that is the usability of the money – utility.

We assume $10 has utility of 1 unit. (This is just an assumption to understand the concept. When multiple objects are involved, their utilities will be different.)

So, the expected utility of this scenario is:

E = ((1000/10)x0.2) + ((50/10)x0.65) + (10000)x0.15) =

20 + 3.25 + 150 = 173.25 units

So, the expected utility – the usefulness of this event is 173.25 units.

The unit of value which we assumed in this calculation is sometimes called ‘utils’ – the basic unit of utility. It will change based on how one perceives the value in given scenario.

You will realize that the expected utility is the weighted average of utility of events and their individual probabilities.

Four Axioms of Utility Theory

Later John von Neumann and Oskar Morgenstern expanded the concept of EUT with the idea of rationality. The agents involved in such uncertain economic exchanges are ‘econs’-the rational beings.

They have clear preferences among the options provided in every economic decision which comes under the idea of “completeness”. If out of the given set they select multiple options at a time, then it is said that they are ‘indifferent’ to these options. Whatever might be the internal distribution of constituent they might have. It’s about the final utility they perceive. When presented with choices, a rational person has clear preferences for those choices.

For all given uncertain events there is a hierarchy of preferences. If A is preferred over B and B is preferred over C, then A is always preferred over C. Which goes as transitivity.

Suppose we have been presented three events where event A is preferred over B and B is preferred over C. Now if one introduces a new event N which is slightly less preferred than B and more preferred over C then event B and N would be indifferent. In simple words, the choices between options would never directly jump, they will align as per the preferences in line.

So, A>B>C and B>N>C then A>B>C and A>N>C mean the same.

This is continuity. Graphically, the utility function is always a smooth curve.

Why do A>B>C and A>N>C mean the same even when the calculated numeric value would differ? It is because utility is never an absolute value it is just used to arrange the preferences by quantifying them. Ground rules used to define usability from the given resources i.e., the utility function of given scenario will be different for different scenarios and different sets of people. This is simplification of the concept called ordinality of utility. You can rank utility but not say that event A is this many percent better than event B.

When you have set the preferences of A over B and if you are offered another totally different/ irrelevant event M with new utility. You would still prefer A over B. Introduction of M will not affect the preferences as if A and B are independent of M. This is called ‘independence‘ in EUT.

So, completeness, transitivity, continuity and independence are the four axioms of EUT. Note that they are not ‘complete’ representation of reality. It’s just that they bring in simplicity to treat given scenarios and evaluate them. That is why you will find contradictions to these axioms. (Maybe a topic for another time.) The axioms are there to create a formal mathematical structure to draw useful inferences.

2^nd Tenet of Expected Utility Theory: Asset Integration

In EUT, asset integration is an idea based on the assumption that all people making economic decisions are rational. So, in uncertainty or risky scenarios a rational person will look at the overall gains instead of focusing on one certain gain and neglecting other unsure gains. A rational person will look at the risks of scenarios in a collective way and decide to enter only if the expected utility improves his assets’ position. A rational person will only enter the given scenario if the collective utility is better than the individual utility of its sub-events or sub-gains.

A rational person will not focus on an individual more probable gain even when his overall gains are becoming low.

3^rd Tenet of Expected Utility Theory: Risk

The beautiful insight EUT creates is about the mathematical formalization of risk profile. For that we will understand some ideas in advance.

Utility function – it is a mathematical relation between how one sees the value of given object/ resource. The value of resources is different for different people. A crude example would be how a beggar values money for one time meal compared to a filthy rich person. The value of $25 would be different for different people based on the conditions they are in.

This is where marginal utility comes in picture.

Marginal utility talks about what difference it makes in your perception of the value of a given thing if one would give you more of that in the next event. Roughly speaking the more we have something, the less we value it, so marginal utility is always diminishing. If I already have 10 packets of chocolates which are enough for the day to me, the next 11^th packet of chocolate won’t make that much difference in my current excitement of having 10 packets. (Please note that we are talking about rationality here, although nobody is rational when it comes to chocolates.) A rational version of me would trade that 11^th packet for something else with a person who hasn’t received even a single packet. A person who has no chocolate would perceive that single packet with higher value than how I perceived it (provided that he loves chocolates).

Alfred Marshall – the British Economist brought the concept of
‘Marginal Utility’ through his book ‘Principles of Economics’ in 1890.

So, utility function is a mathematical transformation of objects in given event to a unitary value so that the results can be easily compared with each other because the transformation converts everything to single unit system. These single unit of value is called ‘util’.

Utility function can be any possible mathematical relation. Generally, it is expected to be simple to not invite the complexities in modeling of given economic scenario. It should be simple enough to draw realistic conclusions.

An understanding of utility function gives insight into how the person evaluates risk with respect to the resources they hold.

Consider a scenario:

Event 1 – You enter a lottery where there is 50% chance that you will win $100 and 50% chance that you win nothing.

Event 2 – You are given $50 for sure, unconditionally just for playing the lottery.

Assume we have three differently thinking people to make choices in this scenario. Different thinking means how they assess the risk of entering the lottery which has some uncertainty and the surety of winning $50. Difference in assessment of risk means difference in the perception of utility. It further means that the utility function will be characteristic to each person.

Person 1 has the following utility function:

So, for Person 1 the utility of certainty (7.07 utils) is higher than the uncertainty (5 utils). He is happy to walk away with sure $50 gain instead of betting for $100 lottery.

Person 1 doesn’t want to take risk by entering the Event 1 of betting when he is sure about gain of $50 in Event 2. This is risk-averse behavior. The utility function mathematically models that risk averse behavior. Utility function is concave in risk aversion.

Now comes Person 2 with the following utility function:

You will see that the utility of certain and uncertain choices is the same. It means that it doesn’t matter for this guy if he enters the lottery having uncertainty or gets $50 for sure. This is risk-neutral behavior. The person 2 doesn’t care about certainty or uncertainty. He values both events the same. As mathematically both have similar utilities. Person 2 is indifferent to both events.

Now see the Person 3 with following utility function:

This guy has a radical view, he perceives the worth of entering the lottery (5000 utils) better than gaining $50 for sure (2500 utils). This guy is gambler! He finds it more interesting to enter the bet instead of gaining $50 for sure. He is happy to take the risk in uncertainty.

Looking at these three people you should note that the scenarios/ events they are presented are exactly the same. The only thing which is different is how they see the value in lottery and the sure gain.

So, the first person demonstrates risk averse behavior. He wants surety of gain rather than gambling for higher but unsure gain.

The second person demonstrates risk neutral behavior. Bet or no bet he doesn’t care. Just be done with it.

The third person demonstrates risk loving behavior. He wants the thrill of uncertainty in betting, so he sees more value in uncertainty of lottery.

This is how Expected Utility Theory can be implemented to mathematically model how different sets of people/fund managers will make decisions based on the risk profile. The relation between expected utility (which is the weighted average of gains) and utility function (which shows how one values the gain) can show us the risk profile.

In the graphs shown, blue lines show utility function and the orange lines show expected utility. The orange line in our case connects the utility of $100 and $0 which is Event 1. This orange line connects any points on utility curve and it will give the expected utility value for that scenario of uncertain gain. In simple words, it’s the line of weighted average exactly like the definition of expected utility. This line is used to find out the certainty equivalent (CE). A certainty equivalent is the utility of an uncertain gain if it was certain.

Almost all the time, people are risk averse. People want to avoid uncertainty about higher gains when they are presented with some lower but sure gain. This is where marginal utility becomes important. (This point deserves broad explanation which we will cover another time under Prospect Theory)

Marginal Utility

In risk averse people, you will see that the utility function starts to flatten out once the value gained increases. The more value someone already has the less he values the next addition of bunch into the preexisting bulk. Remember the chocolate box example?

One with 10 boxes of chocolate perceives one additional box with less value, whereas some with no chocolate will see it as a precious one as he has nothing right now. The perceived value of the additional next lot goes on reducing. This is known as diminishing marginal utility. Marginal utility is always diminishing.

So, a safe playing person would stop entering the next gamble because he now has enough. The next uncertainty in gambling has less value for him.

EUT in actuarial

Now it is obvious that only a risk averse person would go for conservative approach in uncertainty. This also means that risk aversion will also invite preventive measure against loss of certain assets, resources. Insurance thus comes into the picture. EUT here helps to mathematically formalize the probability of the risks which would compromise current gains, the perceived value of asset/ property/ resource and losses one can bear. We can now calculate the premium for the insurance against uncertainty of loss of something.

So, we will look into a scenario where risk aversion exists thus marginal utility is always diminishing.

We have the utility function of a man has a property giving revenue of $100K/year as:

u(x)=ln x

Now will see the risk scenario. Suppose this person does a fire audit of his property and the auditing agency finds out that there is 50% chance that he will suffer a loss of $60K/year due to fire hazard and 50% chance that nothing will happen.

After rephrasing, the gains from the property would look this:

50% chance that the income is $40K/year and 50% chance that income is $100K/ year.

Using the tenets of EUT the mathematical expression becomes:

Now, what we are doing differently here is to find out what this expected utility in uncertainty means when there is complete effect of loss with some chance and gain of some chance. In earlier examples we had second event of certainty against which we compared to understand the risk profile. Now it’s reverse calculation, we know the risk profile, we know the perceived overall value i.e., EUT of the property. Now we will find the certainty equivalent (CE) using the risk profile which can be explained by the utility function of the person.

How much is this 11.05 utils in terms of money from the property for this guy? We can find this from utility function of the person.

ln(x)=11.05, thus x=$63245.55

Now, think the fire hazard as a lottery where you gain $63245.55 money as per EUT calculation. Whether the fire will happen or not, the possible overall earning from this property would be $63245.55.

Now, if the property without any fire hazard was giving me $100k and the insurer guarantees me that same earning for the losses due to hazard. How much maximum amount should I pay to the insurance agency?

I will pay only that much amount which falls short to the $100k when compared to perceived earning calculated from the combined effect of certainty and uncertainty as given by EUT.

My earing due to uncertainty is $63.2k/year, I would receive $100 for a fine year so in order to continue that $100k even for a worse year I would pay insurance agency = $100000 – $63245 = $36754.45.

Anything I am paying above $36754.45/ year for insurance premium is loss for me. I would not go above this amount to insure my property which guarantees income of $100k per year. This is how the insurance premium is decided.

Conclusion:

We have many philosophical ideas about how money is not everything in life but deep down everyone knows that money constitutes a bigger portion of who we are. Although money can’t buy everything, the unexplainable value it holds behind presence of almost everything in our lives will never go unnoticed. We know that this importance of money/ resources/ assets is highly dependent on how much of these we have right now and how much of those may get lost. This perception of value drives our decision making in risky situations. The mathematical formalization of the perception of wealth, our risk profile is facilitated by expected utility theory. Although this theory has its own limitations it lies at the foundation of the economics.

For further reading:

Von Neumann, John, and Oskar Morgenstern. “Theory of games and economic behavior: 60th anniversary commemorative edition.” Theory of games and economic behavior. Princeton university press, 2007
Kahneman, Daniel., and Amos Tversky. “Prospect theory: An analysis of decision under risk.” Econometrica 47.2 (1979): 363-391
Thinking fast and slow – Daniel Kahneman
Connecting money with sentiments – Behavioral Economics
Settling accounts with the losses – On Prospect Theory

A Hindsight For Better Future

Morgan Housel – the famous author of ‘The Psychology of Money’ has another important book called “Same as Ever” which gives insight into things which have never changed over the course of time. Same as Ever drives the motto of objective flexibility and subjective awareness of every event happening around us and with us. It also highlights that our mind is the first and the easiest one to fool, which leads to false sense of superiority over others and creates biases. Once we accept that nothing is perfect, no one is perfect – it injects humility and forgiveness. It also makes us to be grateful for what we possess today. The ability to see every event at the same level is a superpower any one of us can have.

An important book from Morgan Housel called “Same as Ever”

Somebody, make me a time machine

Life would be easy if we had a way to accurately predict the consequences of the events/ actions.

Scenario 1 – what would be your reaction if some random person hands you a $1,000,000 lottery ticket and, in few moments, you realize that you just won that lottery?

Scenario 2 – what would happen if an ambitious project that you worked on tirelessly for many years while sacrificing your other priorities – ends into a big failure because of a seemingly impossible and insignificant event/ error?

For most of us these two scenarios are practically impossible but the odds are still non-zero. They can happen in reality.

How can we be sure that they selectively happen to certain person? Scenario 1 for ourselves and Scenario 2 for our enemies especially… (Just kidding)

If you closely observe the lives we are living right now, you will see that we are always oscillating between such events which demand certainty of outcomes even before the are realized. We have this innate urge to remain ready for such events; it is what we are always striving for.

Now, one question – are we living in a matrix? Is universe a simulation?

If the answer is ‘YES’, then it means that every outcome should be predetermined. If everything is predetermined then why things don’t happen the way we ‘want’? Does that mean that we lack the computational capabilities to precisely calculate the outcome? OR is what is destined to happen different from what we ‘want’?

If the answer is ‘NO’, then everything explodes into meaninglessness. The answers are nihilistic.

Looking at the both outcomes of this question we see that we need a baseline to make our decision making effective. Is there a formula to systematically put all the things happening around? What are somethings in nature whose knowledge will ensure our satisfactory existence. (I am being very optimistic while writing ‘satisfactory’ word here.)

In simple words, what is the formula to live a good life? whether it is predictable or not.

Morgan Housel the famous author of the Psychology of Money wrote one important book called Same as Ever which tries to answer this same question. Same as Ever drives the motto of objective flexibility and subjective awareness of every event happening around us and with us.

This is a deep dive into Morgan Housel’s book “Same as Ever”.

I will try to keep this short. Here are some instructions:

Those who have read this book – each idea in this book is numbered in the sequence Morgan explains in the flow of the book. So, #1 is Hanging by a Thread as mentioned in book and #23 is Wounds heal, Scars last

Those who haven’t read the book – I have given short summary of what Morgan discusses in each of the 23 ideas. That should help you to wrap you head around my distilled down version of this book.

(I apologize for putting that part in the end and spoiling the conclusion/ discussion on this book.)

I would say this book has been one of the most important books I have come across. (I am an average book reader by the way. So, not sure if same would be the case for other people.) While going through each idea, you will realize that something keeps on repeating; and even though it repeats, it brings new perspective into that specific discussion. My attempt to summarize this book focuses on picking what is common but connected to all the facts mentioned in the book and also their connection to the reality we live in.

Discussions

The discussion is in 3 steps, so adjusting our understanding to previous step is key to understand the next step. The illustrative images in each step of the discussion connects the ideas from the book to a common central idea. It will be handy if you read this with the book in your hand or you can jump to the point-to-point summary (the part after conclusion) in a neighboring tab of your web browser.

Step 1 discussion:

Figure 1. Finite and recurring cycle of compounding processes

You will see in the figure 1 that reality is ever changing process of infinite real events. The key to understand what is happening is to see every event containing same potential at first. Keep in mind – same potential – neither good nor bad. Once you assign every event with equal potential you will see that compounding accounts for that single event to build on and create the next event. Sometimes two big events will compound together to create an enormous event.

Now comes the fun part – the enormity of every compounded event will always be in favor of someone and against the favor of the complementary population. This makes that event good or bad for people. Some will suffer some will rejoice.

A person who knows how the world, nature or universe works will not have preferences, favor-ability towards such events. The answer lies in the cyclical nature of such events. Keeping a single event sustained for long duration demands to go many things to work in supporting ways and as every event has same potency in the infinite possibilities, it surely will lead to the downfall of that process. It’s just matter of time.

Talking about matter of time – the game of life is not about winning, rather it is about remaining in the game longer as the compounding pays off and decomposes into new start.

Our limited life span intuitively doesn’t allow us to wait till the compounding pays off. That is exactly where we make mistake. That is exactly why we are devastated by a single seeming insignificant event causing destruction of our favorite things.

Step 2 discussion:

Our urge to predict everything to ensure survival demands perfection in every entity considered for precision and accuracy of prediction. As reality is made up of many real possibilities, this count of possibilities and the errors associated with their measurements require huge resources which render the prediction process impractical for the possible outcomes.

(Keep in mind right now that we are only talking about those variables, events which we can understand; we haven’t even entered into those variables, events we don’t even understand or know in first place.)

The moment we introduce poorly known, immeasurable but significant variable – the whole game of predictability crumbles down.

That is exactly why instead of striving for better predictability, it is a smart choice to be prepared for everything. Knowing that this too shall end soon should comfort us to prepare for such things/ events. The rejection of the urge for perfection, absoluteness and full efficiency will immediately prepare us for everything that reality unfolds.

Step 3 discussion:

Figure 3. In the end, we are only human.

Now that we know how every event is potent and can immediately contribute to a cyclical process of compounding, it is important to understand how we comprehend that compounding. As everything that we do is directly linked to our survival we are by default born with preferences. These preferences get eliminated or amplified based on the life experiences we have. Even though our urge for predictability demands objectivity we often forge the subjective parts of every narrative. The subjectivity is important, because the reasons to survive are different for different people.

Conclusion – Human behavior and laws of nature

Our mind rarely understands anything as a flow of entities. Almost all of the fundamental entities existing in nature are flow – continuum entities. But in order to understand them study them we break them into pieces which makes is practical to quantify and predict. For time as an example – we have past – present – future; we need this separation to comprehend the flow of time. This slight arrangement of separation of events just for the convenience of communication and comprehension for our minds has now become such a second nature of our realities that we could hardly come out of the idea of past and future. Past keeps on haunting and future creates anxiety due to the uncertainty. Nostalgia from past brings us joy and what advancements future will present inspires us to work harder today. We rarely notice that this works both ways.

It is really difficult and impractical for our mind to let go of this past-present-future mentality. This convenience of separation for the sake of improving our decision making and survival has imparted a sense of time being a set of discrete isolated events, independent events. This steals the feature of hyper-connectivity in our understanding of reality.

Once we come out of the discretization of time as past-present-future we will see that every event is equally important and highly interconnected and multidimensional (in the sense that it creates multiple real effects on multiple entities) Our mind being biased for survival and in energy optimization mode, it always focuses on what is required to remain alive. This sense of remaining alive now has evolved into intellectual survival – as in what things we define as our life. So, even though from objective point of view all events remain exactly the same, on our personal level certain events are highly important because they change the things we are attached to in a drastic way – in most cases our life. We are now scared to die intellectually – a mental death – the death of our truths – our identity. And trust me, this happens frequently.

Morgan in this book very beautifully noted down the factual version of the reality we live in; it is beautiful because it shows how our human nature is always affecting the seemingly objective reality of the most of the things.

This is my ultimate distilled down version of the book “Same as Ever” by Morgan Housel.

One point summary of ‘Same as Ever’ by Morgan Housel

It also highlights that our mind is the first and the easiest one to fool, which leads to false sense of superiority over others and creates biases. Once we accept that nothing is perfect, no one is perfect – it injects humility and forgiveness. It also makes us grateful for what we possess today. What else could be more important than this to be justified as a human being?

These points ask for detachment from predictions and end results. A sense of responsibility for the actions could be the best version of any person – this exactly is invoked when we are trying to prepare for the future instead of striving to predict it.

I think we need more ideas like this when we are fighting for survival for such unimportant things where we already know the real, practical answers but have decided to ignore them.

The ability to see every event at the same level is a superpower any one of us can have.

For those who haven’t read the book here is the point-to-point summary of the book “Same as Ever”:

#1. If you know where we’ve been you realize, we have no idea where we’re going.

Here, Morgan gives many real-life events where a single decision led to catastrophic events causing loss of many lives and valuable resources.

When we study history even when we know what exactly happened, it is tricky to pinpoint the trigger for that event. There will be why and how behind every small-small event and when we will reach to its origin it becomes really difficult to wrap your mind around that petty thing which had led to such a big and historic event.

The absurdity of past connections should humble your confidence in predicting future ones.

#2. We are very good at predicting the future, except for the surprises – which tend to be all that matter

In very simple words, Morgan highlights the extents of our imagination and thinking. Even though they are infinite, the nature in which we are existing is equally or rather infinite in bigger and greater sense. That is exactly why even when we think we are prepared for everything, nature will always have something new in its pocket to reveal and not being ready for that exact new thing makes that event overwhelming for us because we were not ready for that exact new reveal.

It’s impossible to plan for what you can’t imagine, and the more you think you’ve imagined everything the more shocked you’ll be when something happens that you hadn’t considered.

This itself should humble us. That is why preparation is more important than forecasting.

Invest in preparedness, not in prediction

#3. The first rule of happiness is low expectations.

The most important observation Morgan puts here is in the ways we gauge our resourcefulness – it is always relative – material or immaterial – objects or emotions. We always have a baseline which is created by comparing ourselves with those around us. That is exactly why we rarely appreciate what we have at our hands.

We always crave for what ‘they’ seem to have instead of appreciating what we already and really have in our hands. Even when we are unsure about whether others actually have those things, still we crave those things for us, which is tragic!

Morgan expresses that almost all of the truly precious things in our life don’t come with a price tag that is why we never care to evaluate their importance – like good health, freedom. Same is the case with expectations.

When Morgan is asking for low expectations, it is not omission of the motivation to improve ourselves. Low expectations ask for realistic expectations. One must always be observant of the gap between what we wanted and what happened in reality.

#4. People who think about the world in unique ways you like also think about the world in unique ways you won’t like.

Here, Morgan talks about the role models, heroes, leaders we consider the best of us all. It is very important to understand that they are the best among us all because they did something in very exceptional manner which made them stand out of the well-defined ‘boring’ and ‘average’ structure of the society. If they would have followed the same paths that other followed, they would have been just like others.

In order to stand out of the masses they did something different.

Now be cautious! This different could be seen as good or bad as per the average crowd level. And keep in mind this specialty in that person is because others don’t have it in them. So, in order to create and develop something special out of the same average crowd one has to overcome a resistance of the masses where a trade-off is done with other aspects of their personality. Sometimes the exceptional conditions create exceptional personalities which many people fail to recognize.

Of course they [successful people] have abnormal characteristics. That’s why they’re successful! And there is no world in which we should assume that all those abnormal characteristics are positive, polite, endearing, or appealing.

Simple words, there is always some trade off to achieve something truly exceptional.

You gotta challenge all the assumptions. If you don’t, what is doctrine on day one becomes dogma forever after

#5. People don’t want accuracy. They want certainty.

A common trait of human behavior is the burning desire for certainty despite living in an uncertain and probabilistic world.

Morgan discusses how we are always trying to alleviate the bad results, pain in all life scenarios. The urge to survive supersedes everything. Our brain always wants a confirmed trigger on whether to fight or flight for given problem. It is always in energy optimization mode and in the uncertain world filled of infinite possibilities it wants something to act on immediately. Otherwise, brain knows that it won’t survive. The urge for certainty – that clarity of whether to fight or flight is the most important information than how precisely we are assessing the reality. It’s like brain takes a shortcut to ensure survival. That is exactly why huge load of information especially numbers overwhelm us.

The core is that people think they want an accurate view of the future but what they really crave is certainty.

#6. Stories are always more powerful than statistics.

If we continue the train of thoughts from previous point, soon we will appreciate how dearly we appreciate stories instead of boring numbers. Even when stories would tell a lie and numbers would tell the real, pure truth we would always choose a fake story over realistic numbers. Our brain doesn’t want to overwork itself to ensure survival.

Good stories tend to do that [evoking emotions and connecting the dots in millions of people’s heads]. They have extraordinary ability to inspire and evoke positive emotions, bringing insights and attention to topics that people tend to ignore when they’ve previously been presented with nothing but facts.

Stories create an emotional, empathic bridge between people which our brain already knows since the childhood. The very first think a baby does to start breathing is crying not counting. (I know the analogy is lame but it works here) we are implicitly trained to actively process emotions first and then numbers. Stories enhance this ability on next level.

That is exactly why emotional-ity will always be preferred over rationality.

We live in a world where people are bored, impatient, emotional, and need complicated things distilled into easy-to grasp scenes.

#7. The world is driven by forces that cannot be measured.

Morgan brings here more clarity on the objective nature of the numbers even when they are showing the truth, the reality. The point that our reality is made up of the infinite possibility itself shows that the sheer limitation of our computation capability will create a partial picture of the bigger reality. This happens because many of the factors which influence our reality are beyond quantification. That is exactly why whenever we are making any decision based on objective and true data (like truest of true numbers) we should bear in mind that these numbers are not accounting for those unmeasured factors which also affect the reality we are trying to understand.

Some things are immeasurably important. They’re either impossible, or too elusive, to quantify. But they can make all the difference in the world, often because their lack of quantification causes people to discount their relevance or even their existence.

In simple words, our story loving brain is driven by intuition and safe/ familiar information which is unquantifiable most of the times.

#8 Crazy doesn’t mean broken. Crazy is normal; beyond the point of crazy is normal.

Morgan is trying to point out how we understand what is means to be at the top. He established that most of the tops we experience in life are to because we have experienced falling down from them and we would have never understood that we were at top unless we have had fall down from them.

The only way to discover the limits of what’s possible is to venture a little way past those limits.

We never appreciate summit of something unless we start climbing from down or fall down from that summit. That is exactly why what made you feel at the top will make you safe and that attachment to safety will lead to your fall, the pain of fall will motivate you to climb new heights and again the cycle will go on.

#9. A good idea on steroids quickly becomes a terrible idea.

Morgan here explains how evolution created the species around us. There was always some trade-off while evolving because of the forces of nature. In nature nothing has absolute competitive advantage otherwise a single species will take over everything that single species alone will lead to its downfall and destruction due to the lack of diversity.

Most things have a natural size and speed and backfire quickly when you push them beyond that.

In simple words, anything that is burns bright, goes out fast. Resources behind every process are limited and even if they would be available in surplus, extent of their utilization affects the outcome and overall integrity of that process.

#10. Stress focuses your attention in ways that good times can’t.

The urge to survive makes our brain to push to its untested limits. These limits are there just for the optimum behavior so that our brain could actually use the reserve energy when it is the question of life and death. When it come down to do or die – people have always delivered in surprising and shocking ways.

The circumstances that tend to produce the biggest innovations are those that cause people to be worried, scared, and eager to move quickly because their future depends on it.

Morgan points out here that this stress should be healthy because there is always a natural size of everything as explained in point #9.

There is a delicate balance between helpful stress and crippling disaster.

#11. Good news comes from compounding, which always takes time, but bad news comes from a loss in confidence or a catastrophic error that can occur in a blink of an eye.

Growth always fights against competition that slows its rise.

Morgan here shows how things that exist today as our reality have gone through multiple iterations. They have already failed many times and started again long ago; its just that the compounding imparted grandeur and power to fight against the adversities of the life which made their realisation possible here in front of us. There will again be some simple, seemingly insignificant event which will destroy this creation and things will start again.

To enjoy peace, we need almost everyone to make good choices. By contrast, a poor choice by just one side can lead to war.

#12. When little things compound into extraordinary things.

Here Morgan points out from the examples of history how in order to avoid a big calamity people ignored some small incidents which led to even bigger calamities. It is ingrained in our mind to overlook big events because the smaller events which lead to their realization are “small and insignificant”.

Small risks weren’t the alternative to big risks; they were the trigger.

#13. Progress requires optimism and pessimism to coexist.

Morgan here talks about how our preferences for each and everything have stolen away the realism in our lives. Instead of favoring one side, life is more about appreciation of the spectrum. It was never about who wins or who loses because both are short lived. It is always about who survived and stayed in the game longer. (Simon Sinek calls it the infinite game as explained in Game theory.)

The trick in any field – from finance to careers to relationships – is being able to survive the short-run problems so you can stick around long enough to enjoy the long-term growth.

Whoever lives to see the end wins but that victory is just over those who couldn’t survive. There will always be some room at the top because conditions never remain the same.

#14. There is a huge advantage to being a little imperfect.

The more perfect you try to become, the more vulnerable you generally are

The idea of perfection immediately steals the flexibility from any given system. Because of the perfection the system is bound to certain thriving conditions and exactly when you expose this system to the reality of infinite possibilities there will always be some ‘seemingly’ trivial event which will take down that whole system.

A little imperfection makes the system to bend thereby giving place to perform in unimagined conditions and as we have already learnt that the reality is full of unimaginable but real events.

Morgan beautifully explains the ways in which natural evolution has worked out.

A species that evolves to become very good at one thing tends to become vulnerable at another.

…species rarely evolve to become perfect at anything, because perfecting one skill comes at the expense of another skill that will eventually be critical to survival.

Nature’s answer is a lot of good enough, below-potential traits across all species.

#15. Everything worth pursuing comes with a little pain. The trick is not minding that it hurts.

The really important and actually valuable things in life don’t come with a price tag and that is exactly why we are not ready to pay any price. This makes our minds to wish for such things because of the false sense of entitlement. This same entitlement blinds us from the real actions which can lead us to this achievement and we keep on whining about not achieving these things. A wishful thinking!

A unique skill, an underrated skill, is identifying the optimal amount of hassle and nonsense you should put up with to get ahead while getting along.

#16. Most competitive advantages eventually die.

A we have now already understood that even a small event can lead to collapse of any grand creation and how easy it is to undermine any event we must now accept that nothing big will stay as it is now. Same goes for any competitive advantage. As things keep changing the advantages which made their impact big will become irrelevant with the changing things. One has to keep on reinventing in order to remain relevant and effective with the changing times.

Evolution is ruthless and unforgiving – it doesn’t teach by showing you what works but by destroying what doesn’t.

#17. It always feels like we’re falling behind, and it’s easy to discount the potential of new technology.

Morgan highlights how the innovations which we consider ground-breaking, world-changing were result of multiple small-small events creating synergy to coexist.

It’s so easy to underestimate how two small things can compound into an enormous thing.

#18. The grass is greener on the side that’s fertilized with bullshit.

You never know what struggles people are hiding.

As we have already seen our urge to compare our conditions with the conditions of others and always consider ours to be the worst most of the times, it is evident that we are experts in judging everything in its entirety based on very little information. Our biases and basic mentality feed this tendency furthermore. But reality is always like the iceberg.

Most of the things are harder than they look and not as fun as they seem.

#19. When the incentives are crazy, the behavior is crazy. People can be led to justify and defend nearly anything.

Morgan here shows that beyond envy people are driven by incentives. You can make people do almost anything, make them believe them in almost any thing if their interests are aligned in that. This is strong when people are helpless and when it is about their survival.

One of the strongest pulls of incentives is the desire for the people to hear only what they want to hear and see only what they want to see.

The beauty that Morgan points out is that this can also be used to bring good out of people.

It’s easy to underestimate how much good people can do, how talented they can become, and what they can accomplish when they operate in a world where their incentives are aligned towards progress.

#20. Nothing is more persuasive than what you’ve experienced first-hand.

As we have emotional beings and we have already seen that we will always prefer emotional clarity of falsehood over the numerical, arithmetic truth it shows that every part of our understanding of life is tied to our own individual experiences. We rarely appreciate the foretold truth. But we will appreciate all those things which we experience on our own.

That is also why there are certain truths which very few people have experienced but are not generally accepted by the masses because there is no part to connect personally. We can only connect personally only when we have passed through those experiences.

That is exactly why it is difficult to convince people of something really exceptional and extraordinary personal experience, that also why it is also easy to fool people.

The next generation never learns anything from the previous one until it’s brought home with a hammer… I’ve wondered why the nest generation can’t profit from the generation before, but they never do until they get knocked in the head by experience.

#21. Saying “I’m in it for the long run” is a bit like standing at the base of Mount Everest, pointing to the top, and saying, “That’s where I’m heading.” Well, that’s nice. Now comes the test.

In simple words, Morgan shows us that we rarely will ever know what we have signed up for. Most of the times our simulative experiences and thoughts will be broken down by the unimaginable possibilities of the reality. Instead of craving for that summit one must try to stand strong while they have started this journey and remain faithful to this step they are taking ahead. This attitude has to be kept with every step which very few people maintain.

Long term is less about time horizon and more about flexibility.

#22. There are no points awarded for difficulty.

Almost all of the times people appreciate certain things, certain people because they couldn’t not have or become like them. This crates a mysticism. We are always attracted to mystical things because the urge to know better (to improve chances of survival against unknown) is our hidden trait.

Complexity creates this mysticism instantly. That is why we most of the time reject truths which are so obvious and in front of our eyes and accept that intellectually stimulating complicated lie. The complexity makes our brain to actively engage in that thing which creates an attachment just because our brain was invested in it.

Complexity gives a comforting impression of control while simplicity is hard to distinguish from cluelessness.

#23. What have you experienced that I haven’t that makes you believe what you do? And would I think about the world like you do if I experienced what you have?

Morgan points out that our lives even though we have common experiences, we associate ourselves to certain groups, certain ideologies on deeper levels and at core we are totally different and individual.

Many debates are not actual disagreements; they’re people with different experiences talking over each other.

References:

Morgan Housel’s book “Same a s Ever”.
Morgan Housel