Making decisions is not just about choosing between two or more options. It’s about taking control of your life and shaping it in the direction you want. It’s about understanding that every decision you make will have an impact on your future. And with the right decision-making framework, you can make better decisions that lead to better outcomes.
In this article, you will be introduced to a framework that can help you make better decisions, whether you’re deciding on specific investments or life-changing choices. You will also learn why good decision-making skills are essential for achieving your goals and living the life you want.
The Role of Luck in Decision-Making
Before we dive into the decision-making framework, let’s address the elephant in the room: luck. Luck plays a role in every decision we make, and sometimes it can be the deciding factor in the outcome. It’s essential to acknowledge that luck plays a part in our lives, and we should respect its influence.
While luck plays a role in the outcome of our decisions, it’s essential to recognize that the narrative fallacy can often deceive us. Luck and fate are important factors, and some people may be born with a pair of aces, but not everyone realizes it. It’s irrational to think that everything we have is solely a product of our behaviour.
The key to success is to play the hand we’re dealt with as though it’s the hand we wanted. A wise player can play a weak hand and still win the game by making rational decisions one after another. Rational, not perfect, is the right word here since every decision has only one outcome, and we can’t judge it solely based on the outcome. Understanding this concept gives us an enormous advantage in life and helps us improve our decision-making quality.
The Making of Rational Decisions
Rational decision-making involves making decisions based on logic, intelligence, and information. It’s not about making perfect decisions with guaranteed outcomes, but about increasing our chances of making good decisions. A rational decision is one that a logical and informed person would have made under the circumstances as they appeared at the time before the outcome was known.
To make better decisions, we need a framework that helps us organize our thoughts and make sense of the information we have. This framework should consider our values, priorities, and goals, among other things. It should also help us identify potential biases and blind spots and provide a way to test our assumptions.
3 Dimensions of Decision-Making: Skill, Knowns and Importance
Making decisions is an essential part of our daily lives, and yet it’s something we often take for granted. However, understanding the different dimensions of decision-making can help us make better choices in both our personal and professional lives.
There are three key dimensions of decision-making: skill and luck, knowns and unknowns, and importance and unimportance.
1 — Skill and Luck
The first dimension of decision-making is the interplay between skill and luck. While we often think of luck as something that is out of our control, it’s important to recognize that both skill and luck play a role in virtually every outcome.
Michael Mauboussin, the author of The Success Equation, suggests that one way to test whether an activity involves skill is to ask whether you can lose on purpose. In games of skill, losing intentionally is possible, but when it comes to games of chance like roulette, losing on purpose is not an option.
In the real world, the role of luck varies depending on the situation. It’s not always possible to predict the probability distribution of outcomes, even with advanced techniques like derivatives and scenario planning.
This is why good decision-makers are comfortable with uncertainty and try to think probabilistically. While it’s difficult to beat the stock market index, some shrewd investors are able to get better-than-average results by minimizing trading fees and taking advantage of the lower house cut.
2 — Knowns and Unknowns
The second dimension of decision-making is the distinction between knowns and unknowns. Uncertainty is a fact of life, and even the best decision-makers are certain of very little.
Instead of focusing on being sure, they try to figure out how unsure they are. In other words, they try to estimate the probability distribution of outcomes to make the best possible decision. However, there are situations where we simply don’t know what the future holds. Richard Zeckhauser calls this state of ignorance.
The best we can do in such situations is to rationally approximate the correct probability distribution and shape by thinking deeply about the problem at hand. By doing so, we can move from full uncertainty to a more manageable level of risk.
The circle of competence is a useful mental model in such situations. By sticking to what we know and understand, we can avoid investing in situations that we don’t have experience with, thus lowering our failure rate.
3 — Importance and Unimportance
The third dimension of decision-making is the distinction between importance and unimportance.
While we make countless decisions every day, many of them are unimportant and don’t really matter in the grand scheme of things. Decisions like what brand of coffee to buy or what colour shirt to wear may seem important at the time, but they ultimately have little impact on our lives.
However, there are decisions that are truly important and can have a significant impact on our lives. These decisions require careful consideration and a thoughtful approach. Whether it’s deciding on a career path or making a major investment, it’s important to take the time to weigh the options and make an informed decision.
The Decision Levels Framework
To make informed decisions, it is crucial to gain a wide interest and curiosity for the world from all perspectives and fields.
To keep rational decision-making in check and avoid letting emotions corrode, we need a comprehensive framework to guide us.
The Decision Levels framework provides a useful tool for filtering information and arriving at optimal solutions.
Level 1 — Observation
The Importance of Being a Great Observer
Observation is the first level of the Decision Levels framework. It’s about collecting information and studying broadly using a wide reading spectrum of annual reports, industry reports, journals, newspapers, and other periodicals, books, etc.
This level is critical because one cannot make great decisions without being a great observer. Studying hundreds of businesses upon businesses helps you know when something wonderful hits your way.
Level 2 — Mental Models
Applying Multidisciplinary Thinking Using the Right Models
Mental Models are the second level of the Decision Levels framework. When an interesting topic is identified at the observation level, you look at how the subject fits into reality through the use of mental models from multiple disciplines.
These models shape the connections and opportunities that you see. Examples of the most important models in every investment decision include the circle of competence and opportunity costs. But there are lots more. One cannot efficiently apply multidisciplinary thinking without using the right models.
Level 3 — Principles
Knowing Your Moral Compass and Setting the Right Principles
Principles are the third level of the Decision Levels framework. Next, you investigate how the subject or idea fits in terms of your principles.
These principles act as the operating system for decision-making. Because while mental models help with comprehension, principles guide behaviour. These are simply imperative.
Level 4 — Checklists
Establishing a Higher Level of Baseline Performance
Checklists are the fourth level of the Decision Levels framework. Lastly, if the topic reaches the bottom level, your checklist for the topic at hand is carried out.
You have different checklists and criteria for different types of decisions and for different aspects of the subject, including bias reduction, risk of the subject, competition, financial shenanigans, etc.
Checklists remind you of the minimum necessary steps in coming to a rational decision and they make them explicit. They not only offer the possibility of verification but also instill a kind of discipline of higher performance.
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This post was previously published on medium.com.
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