Risk Savvy

1. Understand the difference between risk and uncertainty

Risk is when you know the odds. Uncertainty is when you don't.

Risk vs. Uncertainty: Risk involves known probabilities, like in games of chance, while uncertainty deals with unknown probabilities in real-world situations. Understanding this distinction is crucial for making informed decisions.

Implications: In a world of risk, statistical thinking and logic suffice. However, in uncertain situations, intuition and smart rules of thumb become essential. Many real-world scenarios, from financial markets to medical decisions, involve uncertainty rather than calculable risks.

The Turkey Illusion: Beware of treating uncertainty as if it were risk. This "turkey illusion" can lead to false confidence and poor decisions, as demonstrated by financial models that failed to predict the 2008 crisis.

2. Learn to interpret statistics and probabilities correctly

Always ask: What is the absolute risk increase?

Relative vs. Absolute Risk: Relative risk figures can be misleading. For example, a "100% increase" in risk might only mean an absolute increase from 1 in 10,000 to 2 in 10,000.

Natural Frequencies: Present probabilities as natural frequencies to improve understanding. Instead of saying "30% chance of rain," say "It will rain on 30 out of 100 days like this."

Key points for better statistical understanding:

• Ask for the reference class: "Percent of what?"
• Convert probabilities to natural frequencies
• Look for absolute risk changes, not just relative ones
• Be wary of survival rates in medical contexts

3. Beware of defensive decision-making and conflicts of interest

SIC syndrome: Self-defense, Innumeracy, and Conflicts of interest.

Defensive Decision-Making: This occurs when individuals or organizations choose a suboptimal option to protect themselves from potential blame or litigation. It's prevalent in medicine, finance, and management.

Conflicts of Interest: Many professionals, especially in healthcare and finance, face conflicts between their own interests and those of their clients or patients.

Consequences:

• Unnecessary medical tests and treatments
• Financial advice that benefits advisors more than clients
• Reduced innovation and risk-taking in organizations

4. Recognize the power of simple rules in complex situations

Make everything as simple as possible, but not simpler.

Less is More: In uncertain environments, simple rules often outperform complex models. Examples include the 1/N rule for investment diversification and fast-and-frugal trees for medical diagnosis.

Why Simple Works: Simple rules:

• Reduce overfitting to past data
• Are more robust to changes in the environment
• Can be easily understood and applied

Applications:

• Financial investing: Equal allocation (1/N) strategy
• Medical diagnosis: Ottawa Ankle Rules
• Disaster response: Simple triage rules

5. Develop risk literacy to make better health decisions

No decision about me without me.

Understanding Medical Tests: Learn to interpret test results correctly. A positive result doesn't always mean you have a disease, and a negative result doesn't guarantee you don't.

Screening Dilemmas: Understand the benefits and harms of screening tests. For example, PSA testing for prostate cancer and mammography for breast cancer have both benefits and potential harms.

Key concepts:

• False positives and false negatives
• Overdiagnosis and overtreatment
• The difference between relative and absolute risk reduction

6. Navigate financial risks with informed strategies

Don't buy financial products you don't understand.

Financial Literacy: Develop basic financial knowledge to avoid common pitfalls and make informed decisions.

Investment Strategies:

• Consider simple diversification strategies like 1/N
• Be wary of complex financial products
• Understand the limitations of expert predictions

Risk Management:

• Don't confuse uncertainty with calculable risk in finance
• Be cautious of high leverage ratios
• Recognize the potential for systemic risks in the financial system

7. Foster a positive error culture for innovation and safety

A system that makes no errors is not intelligent.

Positive Error Culture: Encourage open discussion of errors to learn from them and improve systems. This approach is crucial in fields like aviation and should be adopted more widely in healthcare.

Good vs. Bad Errors:

• Good errors: Lead to learning and innovation
• Bad errors: Result from carelessness or willful ignorance

Implementation:

• Use checklists and protocols to reduce preventable errors
• Create systems for reporting and analyzing errors without blame
• Celebrate learning from mistakes rather than punishing them

8. Embrace uncertainty in relationships and personal choices

Throw a coin but don't look at the result.

Decision-Making in Relationships: Recognize that many personal decisions involve uncertainty rather than calculable risks. Intuition and simple rules often work better than complex analyses.

Strategies for Personal Choices:

• Satisficing: Choose the first option that meets your criteria
• Social imitation: Learn from others' experiences
• Trust your gut feelings, but know when to question them

Balancing Analysis and Intuition: In matters of the heart, sometimes flipping a coin can reveal your true feelings more than prolonged analysis.

9. Critically evaluate screening tests and medical interventions

If you haven't had a mammogram, you need more than your breasts examined.

Screening Paradoxes: Understand that early detection doesn't always save lives and can lead to overdiagnosis and overtreatment.

Evaluating Medical Evidence:

• Look for absolute risk reductions, not just relative ones
• Consider both benefits and harms of interventions
• Be aware of lead time bias and overdiagnosis in cancer screening

Informed Decision-Making: Use fact boxes and icon arrays to understand the true benefits and risks of medical interventions. Don't be swayed by emotional appeals or incomplete information.

10. Teach risk literacy early to empower future generations

Everyone can learn to deal with risk and uncertainty.

Early Education: Introduce concepts of risk, probability, and decision-making in schools, starting from an early age.

Curriculum Components:

• Statistical thinking and data interpretation
• Understanding of heuristics and biases
• Real-world problem-solving using risk concepts

Benefits: A risk-literate population can:

• Make better personal health and financial decisions
• Understand and participate in public policy debates
• Navigate the complexities of the modern world more effectively

Last updated: August 20, 2024