Should you buy insurance for your health, or your car, or your house? What if you don’t fall ill, or the car doesn’t get stolen, or the house doesn’t burn down in the next 10 years? Is the money wasted?
We see only the visible. Often this is nothing more than randomness. Yet we build narratives to explain what happened. Characterising outcomes as random events is hard to comprehend. It suggests that our efforts and quality of our decisions had nothing to do with the outcome. It’s also a conversation killer as it encourages no further analysis of the matter.
In the real world, it’s very hard to know if a decision is correct even if the outcome is positive. The positive outcome might be a random fluke. For example, if you flip a coin to make an investment decision, not matter how much money you make, it’s still a bad decision.
When decisions are made under uncertainty, the best judge of a decision is not its outcome, but the cost of alternatives i.e. Alternative Histories.
Russian Roulette is a lethal game of chance in which a player places a single round in a revolver, spins the cylinder, places the muzzle against their head, and pulls the trigger in hopes that the gun won’t fire.
The six chambers act as six possible outcomes—six alternative histories—out of which one will come to be. If you were offered $1Mn to play Russian Roulette, how would you measure your decision? Nassim Nicholas Taleb does this interesting thought experiment in Fooled by Randomness.
A revolver has 6 chambers. You’ve got 5 out of 6 chances of becoming a millionaire, and 1 out of 6 chances of ending up dead. The odds are in your favour. If you decide not to play the game, what are you saving yourself from?
Suppose your naive and dumb friend takes the bet and is now rich and famous. How would that make you feel? Would you consider taking the bet now?
Clearly $1Mn won through Russian Roulette is not the same as $1Mn won through years of hard work. Why? Because of the cost of the alternatives.
No matter how good the upside is, the downside is too high—so high that it prevents you from playing any further. Therefore, no matter how many friends win the bet, it’s never a good decision to play Russian Roulette (unless the alternatives are far worse).
If you are in your 20s and your only source of income is playing Russian Roulette, chance are you won’t live to see your 50th birthday. The alternative histories will eventually catch up.
Expected returns don’t matter when repeated exposure gets you out of the game—permanently. As Taleb remarks:
“Assume a collection of people play Russian Roulette a single time for a million dollars. About five out of six will make money. If someone used a standard cost-benefit analysis, he would have claimed that one has 83.33% chance of gains, for an “expected” average return per shot of $833,333. But if you played Russian roulette more than once, you are deemed to end up in the cemetery. Your expected return is … not computable.”
The quality of a decision must not be judged based on the outcome, but by the cost of alternative outcomes.
In the movie Deer Hunter, Mike (played by Robert De Niro) played Russian Roulette with 3 bullets instead of one. The alternative was sure death, so in that context, playing with more bullets so that he had better chances of shooting the captors made sense.
You buy insurance to protect yourself from the alternative histories of falling sick, getting your car stolen, and seeing your house burn down. It’s wise to protect yourself from the events that do not take place.