Bad processes are easy to design. You want to eliminate road accidents?
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Impose a 30kph speed limit. You want to eliminate airport threats? Give each passenger a one-hour check. You want to avoid plane crashes? Ban air travel! Just like in hypothesis testing , a well-balanced decision process requires a proper evaluation of the trade-off between False Negatives and False Positives. The higher the cost of a Miss, the higher is our willingness to bear the cost of a False Alarm. But since the latter must have a limit, in most cases the risk of a Miss cannot be eliminated. Planes will crash. The Hindsight Bias promotes the design of excessively risk averse decision processes.
Left to their own devices, decision makers have an incentive to impose a high cost of a False Alarm on others, in order to avoid the cost of a Miss on themselves — including the cost of self-blame and regret. As Baruch Fischhoff , who pioneered the study of the Hindsight Bias, put it:.
Consider decision makers who have been caught unprepared by some turn of events and who try to see where they went wrong by re-creating their pre-outcome knowledge state of mind. If, in retrospect, the event appears to have seemed relatively likely, they can do little more than berate themselves for not taking the action that their knowledge seems to have dictated. They might be said to add the insult of regret to the injury inflicted by the event itself. When second-guessed by the hindsightful observer, their misfortune appears as incompetence, folly, or worse. By skewing the error trade-off towards private risk aversion, the Hindsight Bias can transform risk management into CYA , promoting bureaucracy and inertia against initiative and accountability.
Interestingly, on the other hand, in the same way that a bad outcome does not prove that a decision process was badly designed, a good outcome does not prove that the process was well designed.
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Again, this might be true: a good outcome may indicate a good process. But it is wrong to conclude that a process is well designed because a good outcome occurred. Just as good decision makers may be wrongly blamed for a bad outcome, bad decision makers may be wrongly praised for a good one. As causes become clear after the event, the question becomes: Why did they see it?
And the hindsight answer is: because they were brilliant, talented, prescient.
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Or better: they knew it all along — sheer genius. Ultimately, this is also bad news for decision makers.
The more they enjoy the praise after a good outcome, the more they will suffer and regret the blame after a bad one. A good decision process cannot be defined by its outcomes. It depends on a clear definition and a balanced attribution of the reward of Hits and the costs of Misses and False Alarms. This site uses Akismet to reduce spam. Learn how your comment data is processed.
As Baruch Fischhoff , who pioneered the study of the Hindsight Bias, put it: Consider decision makers who have been caught unprepared by some turn of events and who try to see where they went wrong by re-creating their pre-outcome knowledge state of mind. Any comments? Cancel reply. Sorry, your blog cannot share posts by email.
Could You Make Money the Madoff Way?
Of course, who knows how much, if any, of the money he collected Madoff ultimately invested. Remember, many of the financial advisers Madoff fooled are paid primarily to separate the wheat from the chaff among hedge funds. I wonder how well they understood split-strike conversions. Many people believe there are investors -- the so-called smart money -- who know the secret to beating the market.
I don't think any such geniuses exist. No one has a crystal ball. Thanks to current technology, detailed information about companies and markets reaches investors almost instantaneously.
That makes it increasingly difficult to beat the market. I think there are managers who -- by dint of a passion for what they do, a disciplined approach, enough smarts and lots of hard work -- can beat the market. But not by a lot, and certainly not all the time. That's why I don't think you should ever pay sky-high prices for a mutual fund or an investment adviser.
You'll likely do best by sticking to common stocks, plain-vanilla bonds and low-cost mutual funds. If you're looking for excitement, maybe you need a hobby. In particular, you should stay away from hedge funds. By definition, these investment pools are barely regulated by the government. On top of that, they charge obscenely high fees. Some hedge funds simply invest in stocks and bonds, but most use esoteric strategies. You can find equally talented managers running mutual funds at a tiny fraction of the cost -- and get regulation thrown in for free.
Of course, the Securities and Exchange Commission failed to detect fraud in Madoff's operations following repeated allegations that he was running a Ponzi scheme. But I'd still rather invest with a manager who is monitored by the government. One last piece of advice: If you hire an adviser or other professional, make sure that you don't sign over a check directly to him or her. That allows your adviser to buy and sell securities for you but prevents him or her from emptying your account and heading for Tahiti.
Steven T. Goldberg bio is an investment adviser and freelance writer. Skip to header Skip to main content Skip to footer. Home investing. Keep it simple How can you protect yourself against his ilk? Most Popular. Coronavirus and Your Money.
Bernie Madoff Definition
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