The key thing for them to examine is the quality and thoroughness of their decision making processes. In the other ninety-nine possible worlds they may have lost their money. The investor who passed on an opportunity for good reasons should not be so quick to regret their decision, then. One might recall the last minute government loans Tesla received in 2010 to save it from the throes of bankruptcy as a relevant Deus ex machina, albeit with Tesla starting out of the gate with an unusually high expected chance of success because of Elon Musk. If we run “startup history” a hundred times, analogous to taking the coin flip bets above repeatedly, perhaps this particular startup succeeds massively only once due to eleventh hour luck and fails ninety-nine times.
What if the successful startup they initially turned down on had a low expected chance of success due to factors like unlikely FDA approval or high capital intensity? But this line of thinking can be fraught with fallacious thinking. Many Silicon Valley VC’s lament turning down seed stage opportunities once whatever hot startup they initially passed on has finally achieved success years later. Take the decision to invest or not in any given startup, for example. This simple example is representative of the confusion around many decisions in investing, politics, and life. If you get lucky and the coin lands on heads, you don’t deserve to celebrate your win here, because your initial decision to take the bet was misguided. You now have to pay your friend $2 if the coin lands on heads, but you get paid $1 if the coin lands on tails. But as you know, this is a fool-hardy response, since in this particular case the realized value happened to be less than the expected value of the decision.
If you take the bet and the coin lands on tails, you might be lamenting your decision. Intuitively and mathematically, this is a good bet for you. The expected value of this simple bet is (.5 X $2) + (.5 X -$1) = $0.50. If the coin lands on tails, you pay your friend $1. After flipping a fair coin (only once), if the coin lands on heads, your friend pays you $2. To illustrate with a very simple example, let’s say your friend offered you the following bet. Expected value signifies the probability based value of making a decision at the time it was made, assuming long-run repetitions of the decision. This confusion has critical implications for decision-making in investing, diplomacy, and even daily life.įor the purposes of our discussion, realized value signifies the end result, positive or negative, of how a decision actually turned out in real life after it was made. We often confuse realized value with expected value and learn the wrong lessons from our decisions. Each time, after making the same kinds of mistakes again, he utters a deadpan “I’ve made a huge mistake”.Īfter making a decision that turned out poorly, it’s tempting for us to take after Gob and lament our mistakes. I’ve made a huge mistake - the dangers of ignoring expected valueįor fans of the show Arrested Development, the character Gob provides endless comedic relief as he bumbles through life and his magic tricks, ahem, illusions, with enthusiasm and idiocy.