In my previous post about the lessons I learned in 2018, I mentioned that I’ve been reading extensively on Mental models. One of my favorite mental models is Base Rates.
“Base rate” is a technical term of describing odds in terms of prior probabilities. The base rate of having a drunken-driving accident is higher than those of having accidents in a sober state.
Knowing the base rate is the next best thing to psychic ability. How often something has occurred in the past is usually a good indicator of how often it will occur in the future.
Like Annie Duke said in her recent newsletter:
Base rates are like having a crystal ball.
Seeking out the base rate in our decision process reminds us to not put so much weight on our own experience and own opinions.
Always asking, “how often does this typically happen?” helps us view the decision from the outside in, rather than the inside out.
When you evaluate whether smoking is good for you or not, if you look at the average experience of 1,000 smokers and compare them with a 1,000 non-smokers, you’ll see what happens.
People don’t do that. They get influenced by individual stories like a smoker who lived till he was 95. Such a smoker will force many people to ignore base rates, and to focus on his story, to fool themselves into believing that smoking can’t be all that bad for them.
Charlie Munger, instructs us how to think about base rates with an example of an employee who got caught for stealing, claiming she’s never done it before and will never do it again:
You find an isolated example of a little old lady in the See’s Candy Company, one of our subsidiaries, getting into the till. And what does she say? “I never did it before, I’ll never do it again. This is going to ruin my life. Please help me.” And you know her children and her friends, and she’d been around 30 years and standing behind the candy counter with swollen ankles. When you’re an old lady it isn’t that glorious a life. And you’re rich and powerful and there she is: “I never did it before, I’ll never do it again.” Well how likely is it that she never did it before? If you’re going to catch 10 embezzlements a year, what are the chances that any one of them — applying what Tversky and Kahneman called base rate information — will be somebody who only did it this once? And the people who have done it before and are going to do it again, what are they all going to say? Well in the history of the See’s Candy Company they always say, “I never did it before, and I’m never going to do it again.” And we cashier them. It would be evil not to because terrible behavior spreads (Gresham’s law).