3 key flaws when predicting risks

Book Review: 'Risk Intelligence: How to Live With Uncertainty'

Book Review
Title: "Risk Intelligence: How to Live With Uncertainty"
Author: Dylan Evans
Publisher: Free Press, 2012; 288 pages; $20.80

Depending on your perspective, you might perceive the world as a risky place or a safe one — or as one full of adventures and possibilities. According to Dylan Evans, author of "Risk Intelligence: How to Live with Uncertainty," our ability to evaluate probabilities also varies widely from person to person.

Evans calls our individual powers in this arena our risk intelligence, and developed an online RQ test and other research that revealed that RQ and IQ are completely different animals, as well as surfacing the troubling reality that relatively few people have strong RQs — even among those whose jobs are to give expert assessments of risk in their field.

In "Risk Intelligence," Evans highlights a key set of thought flaws that frequently foil most of us when we make efforts to understand and predict the risks we face; some of the most critical include:

1. Imagination inflation. This is Evans’ casual nickname for something scientists call the availability heuristic: our illogical tendency to estimate the chances that something will happen in the future based on how easily we remember something similar in the past — even if the memory is from a film, a TV show or other fictional account!

In one study, for example, subjects were asked to rate the chances that various unlikely things had happened during their childhood, like breaking a window with their hand. Weeks later, some were asked to picture these things happening in their minds’ eyes, and others were not asked to imagine them; then all were asked again how confident they were that these events had taken place during their youth.

Article continues below

Those who were not asked to imagine them were 20 percent more confident that the events had happened, based solely on the suggestion of the questions; those who were asked to actually imagine them were a full 30 percent more confident that they had experienced the events. (Think about what this would mean for criminal juries — yikes!)

Evans says that this imagination inflation causes us to overestimate the probability of dramatic risks and to underestimate risks that are harder to visualize; he suggests that we must be cautious about falling prey to either of these extremes.

2. Worst case-ing the joint. Evans defines worst-case thinking as the logic-ruining tendency to "transform low-probability events into complete certainties whenever the events are particularly scary." He points out that it stops us from considering the benefits piece of the cost-benefit analysis that is a necessary part of every decision in life and, like imagination inflation, allows vivid imagery and fear-driven decision-making to crowd out rational thought.

3. Overconfidence. On the other end of the confidence spectrum, many a behavioral economist has pointed out the decision-destroying implications of being overconfident in your investment prowess, which I suppose is another way of saying overestimating your RQ for picking investments and timing the economic markets, real estate included.

Evans posits that overconfidence is not only exceedingly common, but a whole-life issue when it comes to assessing risk — not just a financial one — placing RQ right on a "golden mean lying halfway between overconfidence and underconfidence."

Here’s where Evans cautions readers about the challenges of working with experts in an effort to understand risk: Just because someone has expertise in a particular subject matter does not necessarily mean they know precisely how much they do and do not know.

In Evans’ own words, "[experts] often think they know more than they really do." Rigorous reliance on data about outcomes, versus expert opinions, is Evans’ suggestion for mitigating the overconfidence of experts.

"Risk Intelligence" is a comprehensive, research-packed tour through the realm of probabilities and the thought flaws and failures that stop us from predicting them accurately, whether we’re talking about likely surgical outcomes or how that fully adjustable, stated-income mortgage is likely to turn out.

It might be a little involved for the average layperson seeking to simply make smarter decisions in his everyday life, but I suspect that those who devote much of their time and effort into planning their finances might find in it an entirely new outlook on expert advice and data-based decision-making.

Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com.

                                                   

Contact Tara-Nicholle Nelson:
Facebook Facebook Facebook Twitter Facebook Email Facebook Letter to the Editor


Comments