TIP715: Thinking in Bets by Annie Duke
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You're listening to TIP. Have you ever made a decision that turned out poorly and immediately assumed it was a bad decision? Or maybe you got lucky and things turned out well for you and thought you made a brilliant call. In today's episode, we explore why those snap judgments can be so misleading and lead to poor decision-making. We're diving into Annie Duke's powerful book, Thinking in Bets, where she shares practical ways we can make better decisions

and overcome a host of behavioral biases. Most decisions are made under uncertainty, with incomplete information, and luck plays a big role in the outcome. But judging your decisions based solely on how things turned out can keep you from learning and improving. Annie teaches us how to separate decision quality from results, and she introduces the concept of resulting, a trap we all fall into, and shows how it clouds our judgment.

Whether you're investing, leading a team, or making everyday choices, the wisdom that Annie shares will sharpen the way you think. And by the end of the episode, hopefully you'll have a better framework for making smarter decisions when faced with enormous uncertainty. With that, let's dive right into today's episode covering thinking and bets by Annie Duke.

Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Playthink.

On today's episode, we'll be chatting about Annie Duke's book, Thinking in Bets. Annie Duke is not an investor, but she is an avid student and expert on the topic of decision-making. Annie spent 20 years as a professional poker player and won a number of major poker events, including the World Series of Poker Gold Bracelet, and earned $4 million in poker tournaments before retiring in 2012. Through her experience playing poker, she realized that she had almost by happenstance

entered an arena where she could learn how people learn and make decisions. A poker hand takes about just two minutes, and over the course of a hand, up to 20 decisions might be made, and at the end, there's a concrete result. Either you make money or you lose money. The result of each hand provides immediate feedback on how one's decisions are faring, but the outcome itself isn't directly correlated to the quality of one's decision.

Somebody with a 2-7 offsuit can go all-in preflop and still manage to win the hand purely by the luck of the draw. A bet made in poker is simple, but also important to understand. It's simply a decision about an uncertain future. Thinking of bets in these terms helped Annie avoid common decision traps, it allowed her to learn from results in a more rational way, and enabled her to keep her emotions out of the process as much as possible.

In framing poker in this way, it's easy to see why there is so much to learn from this game because we're making decisions about an uncertain future in so many aspects of our lives, whether it be investing, stock picking, business, et cetera. For example, in building our TIP Mastermind community, I've been surprised by how many of our members are former poker players. One member from the UK, for example, spent part of his life playing professional poker

and later was the CEO of a nine-figure manufacturing company. I believe that Annie is one of many examples of someone who used poker as a tool to upgrade their thinking, think in more probabilistic terms, and identify one's cognitive biases. At the end of the day, our lives are primarily determined by two things, the quality of our decisions and luck. Learning to recognize the difference between the two is what thinking in bets is all about.

And he opens up the book by telling a story about American football. In Super Bowl XLIX in 2015, the Seattle Seahawks were on the one-yard line on second down against the New England Patriots with 20 seconds left. Everyone expected the Seahawks to hand the ball off to their exceptional running back, Marshawn Lynch, punch it into the end zone, and score the game-winning touchdown. Instead, Seahawks coach Pete Carroll called a pass play, and the Patriots intercepted the ball

winning the Super Bowl shortly after. All of the headlines the next day were absolutely brutal, and they criticized the atrocious play call. USA Today wrote, "What on earth was Seattle thinking with worst play call in NFL history?" The New Yorker called it, "A coach's terrible Super Bowl mistake." Despite nearly everyone criticizing Carroll's decision, a few voices argued that it was a sound play call considering the importance of clock management

and end of game considerations. The odds of an interception being thrown on that play was estimated to be around 2%. In that season, there had been 66 pass attempts from the one yard line, none of which had been intercepted. Plus, if an incomplete pass had been thrown, the Seahawks would have had two more opportunities to hand it off to Lynch and win the game. Even with this reasoning, most didn't care to give Carroll any credit at all for the play call,

And the simple reason for this was that the call simply didn't work and they lost the game. Had the pass been completed and the Seahawks won the game, every headline would have praised Carroll for his brilliant play calling. And had it been an incomplete pass, then the play would have been completely forgotten about. The simple reality is that Pete Carroll got unlucky. He had control over the quality of the play call decision, but not over how it turned out.

He called a play that had a high probability of ending with either a game-winning touchdown or an incomplete pass, but sometimes good decisions can lead to bad results. Poker players refer to this behavioral bias as resulting. When Annie first started playing poker, more experienced players warned her about the dangers of resulting, cautioning against changing your strategy just because a few hands didn't turn out well in the short run. To equate this with investing,

Let's say you find a business that you deem to be investable. It checks all of the boxes in terms of your ability to understand the business, the business's quality, the management team's skin in the game, and finally, you're able to get in at an attractive price. If next week, the company reports their biggest earnings miss in company history and the stock drops by 20% overnight,

Robert Leonard : Most newer investors would likely assume that they made a massive mistake and potentially even sell the stock right on the spot. I remember when I first started investing, I would obsess over the minute by minute stock price movements. I vividly remember buying shares of Apple at 130 bucks a share in 2015, and I felt like I made a mistake after the shares declined by over 30% in the months that followed. Had I been smart, I would have loaded up on more shares.

Now, in the example of the earnings miss, we have to ask ourselves if there was any potential way we could have predicted such a bad quarter prior to initiating the position. Investing, like poker, is a game with incomplete information. There's valuable information related to the business that is perhaps hidden or we wouldn't be able to uncover without getting insider information or working at the company ourselves. I could see an example where if the management team isn't ethical and they have tried to

massage the EPS numbers in the past to their own liking, or in recent quarters, there has been declining growth, then perhaps a bad quarter could have reasonably been seen coming just around the corner. But many great companies do disappoint from time to time. So we shouldn't fall prey to resulting and equate that to the quality of our decisions and investing. Some things we simply can't see coming. We just have to do the best we can with the information that we have.

To further illustrate how people can fall prey to resulting, Annie often asks executives to share with her the best and worst decisions they've made in the past year. She's yet to come across someone who doesn't identify their best and worst results rather than their best and worst decisions. For those that are new to this concept, it's a reminder that this is just one of many examples that illustrate that our brains aren't built to be rational.

Our brains evolved over time to create certainty and order, and we're uncomfortable with the idea that luck plays a critical role in our lives. Seeking certainty is what enabled the human species to survive for millennia and not be overtaken by predators. Given the critical role of luck in investing, it's easy to see why most people shy away from the field or outsource the job to someone else they deem to be an expert.

Counterintuitively, it can be better to evaluate decision quality when you are blind to the outcome. In an area like poker, this is especially counterintuitive because the outcome is known shortly after the hand begins. To address this, many expert poker players often omit the outcome when seeking advice about their play. Annie would conduct these poker seminars for players newer to the game, and she would describe a hand up to a decision point.

and discuss what a high-quality decision would look like, and then leave off how the hand would actually end. This is exactly how she was trained, and the group would be shocked and just teetering on the edge of their seats wanting to know how the hands turned out, to which Annie would say that it simply doesn't matter. The point isn't to be right 100% of the time, but it's to make the highest quality decisions possible. Daniel Kahneman, in his bestselling book, Thinking Fast and Slow, popped

popularize the labels of System 1 and System 2 thinking. System 1 thinking we can think of as fast thinking. This is the reflexive, instinctive, impulsive, and automatic type of thinking. On the other hand, System 2 thinking we can think of as slow thinking. It's more deliberate, concentrated, and it requires more mental energy. When a journalist considers Pete Carroll's play call atrocious, they're likely using System 1 thinking.

When an analyst takes a step back and really thinks through the situation and all of the potential outcomes, they're using system two thinking.

Oftentimes, system one thinking is required and serves us well. If we're driving down the highway and a deer jumps in front of our vehicle, then this likely isn't the time to be using system two thinking as you have a fraction of a second to react and potentially steer around the deer. Many of our shortcomings as decision makers originate from the pressure on our system one thinking to want to do a job as fast as possible without thinking about the long-term ramifications.

As investors, we can be grateful that we don't have the rules that poker players do. Professional players need to make hundreds of decisions with significant financial consequences over the span of several hours, and many critical decisions need to be made within, say, 30 or 60 seconds. As long-term investors, we could take months to contemplate entering or exiting a position, enabling us to fully utilize all of the available information, speak with other investors to learn more about their viewpoints,

and tap into our system two thinking. And he also highlights the importance of acknowledging that we cannot know everything. In a world that is uncomfortable not knowing, getting comfortable with saying things like, "I don't know," and "I'm not sure," can help us become better investors because we're able to acknowledge that the future is fundamentally uncertain. Many things in investing just aren't black or white. They're somewhere in the gray area. Once we can sift through this nuance and think more probabilistically,

We cannot feel so bad about things not going our way and thinking things like, "I knew it," or "I should have known," after an outcome has occurred. Great investors know that sometimes you make a decision and it can still lead to an unfavorable outcome. In fact, there are already a number of stocks in your portfolio that are probably mistakes to be there. You just don't know which ones exactly in advance. The influence of luck makes it impossible to predict exactly how each investment is going to turn out.

"Setting proper expectations allows us to not get so down on ourselves when we inevitably find ourselves holding onto a losing stock." In line with the title, Annie shares that all decisions are bets. Merriam-Webster defines a bet as a choice made by thinking about what will probably happen and to risk losing something when you try to do or achieve something. I've noticed that many value investors will proudly state that they've never gambled or never visited a casino or purchased a lottery ticket.

But no one can get around the reality that we are all thinking in bets every single day. We're all betting our time to optimize for some sort of outcome. By researching one stock, we're not researching thousands of other stocks. For time spent reading, we're not spending time with our spouse or our kids or exercising or doing anything else. It's easy to recognize that stock investing is very much like betting, but it's also easy to overlook that other aspects of life are like betting as well.

Job and relocation decisions are bets. Sales negotiations and contracts are bets. Buying a house is a bet. Mostly everything's a bet. Annie has this section in her book titled, Hearing is Believing, that I just really resonated with. When she speaks at various events, she sometimes asks the audience a couple of questions. The first is, who here knows how you can predict if a man will go bald? And usually the response is to look at the maternal grandfather.

And everyone in the audience will, of course, nod in agreement. Another question she'll ask is, does anyone know how you calculate a dog's age in human years? And many in the audience will immediately say to multiply by seven. Both of these widely held beliefs simply are not accurate. It turns out that baldness is impacted by the person's father and the dog to human age ratio is just a made up number. Many of the beliefs we hold are formed in a haphazard way.

leading us to believe all sorts of things based on what we hear out in the world, but haven't researched ourselves. Most of us would believe that our beliefs are formed in the following sequence. First, we hear something. Second, we think about it, vet it, and determine whether it's true or false. And third, we form our belief. It turns out that we actually form abstract beliefs this way. First, we hear something. Next, we believe it to be true.

And only sometimes later, if we have the time or inclination, we think about it and vet it determining whether it is in fact true or false. Robert Leonard : Harvard psychologists have found that our default is to believe that what we hear and read is true. Even when the information presented is clearly false, we are still likely to process it as true. Now, this clearly causes issues in the world of investing. On X or Twitter, we might come across a bullish stock write-up. On sites like Value Investors Club,

we come across the hidden gem. Wherever it might be that we gather information, we tend to believe that information to be true. This is why it's critical that we're mindful of who we're gathering information from. People are notoriously bad at changing their beliefs in light of new evidence, and I think it's safe to say that we're all biased in some way, shape, or form based on our upbringing, the way we consume information daily, where we live, where we work, etc.

Annie shares the example of a fierce rivalry game of American football between Princeton and Dartmouth all the way back in 1951. Princeton was the favorite and won a brutally competitive and hard-fought game 13 to nothing that included many penalties and injuries. Psychology professors use the game as an opportunity to study how beliefs can radically alter the way we process a common experience. Students from each school perceive the game in

entirely differently. Princeton students saw that Dartmouth committed twice as many flagrant penalties and three times as many mild penalties as Princeton. And Dartmouth students saw each team commit an equal number of penalties. Their fundamental beliefs and their identities drastically impacted the way the students processed information. This story reminds me of my days reffing basketball. I've reffed basketball to a varying extent for over 10 years,

And now I only do it each winter as a volunteer for the high school I went to growing up. A number of years back, I reffed basketball as a job. I would reff games where I wouldn't know any of the players or coaches going into the game. And I vividly remember reffing a middle school boys basketball game. And I did not know a single person in the gym going into that game. I don't remember the teams, but the team that was clearly better won by 15 points or so.

It was a pretty competitive game, but the better team won fairly handily. It should probably go without saying, but I truly try to do my best in officiating and making it as unbiased as possible, which is a close to impossible task, but worth striving for. After the game, I was picking up my things and heading out of the gym, and an older fan approached me who was from the losing team, and he told me that that game was the most lopsided game

in terms of the officiating he had ever seen. I was just shocked to say the least, and I wondered if he was watching the same game that I was. In my mind, the better team had won, the fouls were called consistently on both sides, and I, as the official, tried to let the kids play a competitive game. I, of course, tried to call the game as fairly and consistently as possible, and I had absolutely zero reason to favor one team over the other in the calls I was making.

Now the fan that's in the stands, he might have saw his grandson not making any shots. Maybe he saw a couple of fouls called on the player, and maybe he made a few turnovers against a pressure defense. If I were related to this player and I really wanted him to do well, I would have likely seen the game in a totally different light. When I heard this from the fan, I just sort of laughed it off because I knew I wasn't going to be changing his mind.

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All right, back to the show. It's just another example of how biased we all are. And that's just the way it is when you're interacting with people with different perspectives that have different experiences. Worse yet, once a belief is lodged into our minds, it becomes extremely difficult to dislodge it. It takes on a new life of its own, leading us to notice and seek out evidence confirming our belief, rarely challenge the validity of confirming evidence,

and ignore or work hard to actively discredit information contradicting that belief. To compound this issue further, sites like YouTube, X or Twitter, and Facebook use algorithms to keep pushing us in the direction we're already headed, further entrenching the beliefs we hold. They know very well what it is we believe and like, and will continue to serve us such information, shoving each and every one of us into our own echo chamber. As you're listening to this,

It's easy to assume that you aren't like most people, and you're smarter than everyone else, and have an open mind to new ideas. To that point, I would add that Annie believes that smart people can actually be more biased because the smarter you are, the better you are at constructing a narrative that supports your beliefs. In 2012, psychologists found that people are better at recognizing biased reasoning in others, but are blind to their own personal biases. We all have a blind spot for recognizing our biases.

and the blind spot bias is likely greater the smarter you are. One way we can hedge against our biases from an investment perspective is to put a confidence level on each stock in our portfolio and watch list and weigh each position accordingly. You might have a spreadsheet that evaluates each company on a scale of one to 10, and those that receive a higher ranking will receive a higher weight in the portfolio. We might believe the prospective returns are high on a stock,

But if our confidence is 3/10 or 5/10, then we likely wouldn't want that to be the biggest position from the outset. By being honest about our confidence or conviction levels, we can be more open to disconfirming evidence if we come across it. Annie writes here, "There is no sin in finding out there is evidence that contradicts what we believe."

"The only sin is in not using that evidence as objectively as possible to redefine that belief going forward." A bit later, we'll be chatting more about utilizing a peer group to help get information that contradicts your existing viewpoints. In chapter three, Annie discusses how we can learn how to bet more effectively. The first lesson is to learn from our experiences. Philosopher Aldous Huxley stated, "Experience is not what happens to a man.

It is what a man does with what happens to him." Many people get experience, but don't learn from the feedback they get from such experience. And he breaks this process down into three simple steps. First, we have a belief. Second, we make a bet or decision based on that belief. And finally, we have an outcome. The outcome is influenced by two things, the quality of our decision and luck.

Oftentimes, the difficult part is determining how much luck was involved in the outcome. In poker, of course, this can be quantifiable if you know the cards and the data set, but in investing, it's largely unquantifiable. If we determine that our decisions drove the outcome, we can feed that data we get into our belief system, informing us to make future bets or decisions.

In vetting the guests we bring here on the show, I'll usually look at the types of companies that person invests in and their performance relative to the S&P 500. More often than not, the investors that have beaten the market have a tendency of buying and holding good companies instead of being someone who looks for deep value. If I analyze 10 investors who beat the market through stock investing, my guess is that seven or eight of them focus on buying and holding great companies, and maybe one of them is a deep value investor.

Now, that doesn't necessarily mean that one strategy is better than the other because the past decade has certainly favored one approach over the other. It was likely much more profitable to bet on Amazon in 2015 rather than the brick and mortar retailer trading at 50% of its net asset value.

Given my own biases and the people I've met and interviewed here on the show over the years, I have a bias towards favoring the businesses that are growing faster and have a long track record of value creation over the business that appears to just look ridiculously cheap. I, of course, think my strategy is going to deliver satisfactory returns, but I'll still try to keep an open mind and update my assumptions in light of how things pan out for my own portfolio to improve my belief system and decisions going forward.

When receiving feedback on our decisions, we can broadly put the outcome into the skill category that was due to the quality of our decision or in the luck category, which is primarily driven by luck. One of the problems with stock investing relative to poker is that the feedback loops are incredibly long. The most skilled investors can have poor returns for multiple years and the least skilled investors could have the best returns over the same period. 1999 and 2021 are likely two of the most extreme examples.

In 1999, shares of Berkshire were falling while the market was skyrocketing, and know-nothing investors were making 5, 10, or 20X their money on internet stocks. In the long run, skill prevailed and Buffett still came out on top due to his superior skillset. This is why it's critical to not take your performance too seriously after one quarter, one year, or maybe even three years. Perhaps the wind was at your back and the sales were pointed in the perfect direction.

and you just happen to be in the right place at the right time. When you throw uncertainty into the equation, learning from our decisions can be a painful process because it's just so difficult to distinguish the skill from the noise.

Partly due to this reality, people have a tendency to fall prey to the self-serving bias, believing that they are skilled and their misfortunes are primarily due to luck. Phil Hellmuth, who has won more World Series of Poker bracelets than anyone, which is 17, he's famous for getting eliminated in a televised tournament and stating on camera, "If it weren't for luck, I'd win every one." While this likely shocked most poker players to believe that all of his misfortunes were due to luck,

In many cases, he was probably the only one to have said it out loud for everyone to hear. Poker, like investing, is also a game where there's a lot to learn from watching other people. This show has been built on studying and interviewing the greatest investors, starting with Warren Buffett and working our way down the list of greats. In poker, an experienced player is going to be folding around 80% of the hands they're dealt, which means that 80% of the time,

They're simply just watching the game being played and watching other players. Not only are the lessons from the outcomes plentiful, but they're also free. In investing, we can do things like follow 13 Fs and see what successes and failures the greats are experiencing. We can look at concentrated investors like Lee Liu, Brian Lawrence, Chuck Ockrey, Dev Kondisaria, and Josh Tarasoff, and see if they're making any big bets they have high conviction in. And we can simply watch the successes and failures of those around us

but this can be a dangerous game to play as well. When it comes to happiness, many people would point to basic things that are required to be happy, such as a comfortable income, good health, a supportive marriage, and a lack of tragedy or trauma. Sonja Limbomirsky, a psychology professor at the University of California, found strong evidence that these factors do play a role in happiness, but not as big of a role as one might expect.

What accounted for most of the variance in happiness is actually how we're doing relative to others. Carrying these findings to investing, comparing yourself to others too much or at all can lead to detrimental outcomes such as taking on too much risk or taking on more risk than our capacity to handle it. Gautam Bade, the author of The Joys of Compounding, is one of the most humble investors I've come across during my time here at TIP. Over the holiday, he sent me a blank gratitude journal

which is a tool he uses and sits down with every single morning and evening. He'll write down three things he's grateful for, three things that will make today great, three positive affirmations, three highlights of the day, and three things learned from the day. I think that it's pretty clear that something like a gratitude journal can help keep our emotions in check and help us be grateful for the simple things in life that hundreds of millions of people globally simply don't have.

It can also almost help rewire the feedback loop in our brain where instead of constantly comparing ourselves to others, each day we can tap into what is actually most important to us and how lucky we already are simply due to where we're born. One thing that Buffett does frequently is openly discuss his mistakes in his annual shareholder letters. He doesn't shy away from admitting errors, often calling them dumb decisions.

For example, he's repeatedly highlighted his missteps like buying a failing textile mill called Berkshire Hathaway, investing in US Air in 1989, or failing to buy Google. By acknowledging these blunders, he sets a tone of transparency and self-awareness. Buffett also contrasts his errors with successes, reinforcing the idea that even the best investors are fallible. He frequently jokes about his past misjudgments, and instead of blaming others, he takes full responsibility.

His approach demonstrates that learning from errors is more important than avoiding them entirely. And by doing so, he keeps his ego in check and remains relatable despite his immense success. In chapter four, Annie dives into what she refers to as the buddy system. She explains that in many situations, people simply aren't seeking the truth. She tells a story in the book of another poker player that had a bad beat playing a six, seven of diamonds.

And the player chatted with Annie about the play during the break. And Annie responded by asking why in the world were you playing a six, seven of diamonds in the first place? Essentially making the claim that he shouldn't have been playing the hand at all, even if it looked like he was going to be winning the hand going into the river. Perhaps the player just wanted some playful banter during his break or have his confirmation bias supported. He likely wasn't seeking the truth in that situation. And Annie didn't hesitate to deliver him the truth.

There is almost an implied contract that was broken in that scenario. This is a situation I think we all come across in life. In most, if not all situations, the truth can just be painful to hear. No one likes to be told that they made a mistake, they made a terrible investment decision, they've neglected their health, they've treated other people poorly, or they haven't invested in their relationships. Our brains have evolved to make our version of the world where

or our version of the truth more comfortable. This means that we believe that our beliefs are always correct. Favorable outcomes are the result of skill. There are plausible reasons why unfavorable outcomes are beyond our control, and we compare favorably with our peers. We deny or at the very least dilute the most painful parts of the message. Working against our natural instincts is not the easy choice.

Poker is a lot like life in a sense that it's easy to make excuses as to why things did not pan out the way you would have liked. Of course, luck plays a role, but we tend to overestimate the role of luck and underestimate the role of skill. It's funny when I think about the occasional poker game that I've played in, more often than not, I just don't get good cards. I know that if I improved my poker skills, then I would have played better, but it's easier to just say that luck didn't go my way.

I think that life and investing are very similar. Annie discovered in the world of poker that thinking in bets was easier if she had other people to help her view the world more objectively. Thinking objectively is difficult on your own, and having someone to hold you accountable can help you improve your skillset and be more mindful of your own biases. Since most people don't want to hear the truth, you need to actively seek out a buddy that is both skillful and willing to help you find the truth.

It's about finding someone who is willing to disagree with your viewpoints, even when it's uncomfortable to do so. This is one reason I love being a part of our TIP Mastermind community. In the community, I'm surrounded by thoughtful investors who have much more experience than I do, and I'm able to get good feedback on my ideas. I think for most people, having those seeking truth can be immensely valuable in our lives, but not everyone needs to have that sort of mindset in order to be included in our lives.

Perhaps we have some friends we just talk sports with, we have family members with their own interests, and we have those who help push us professionally. Each person in our life can play their own unique role. But we need to be careful with the buddy system that we aren't simply surrounding ourselves with people who are happy to agree with us and just simply reinforce our existing beliefs. Annie shares that there are broadly three characteristics of a good truth-seeking group.

First is the focus on accuracy over confirmation, which includes rewarding truth-seeking, objectivity, and open-mindedness within the group. Second is a focus on accountability, for which members have advanced notice. And third is an openness to a diversity of ideas. She highlights that the goal is to become more objective and not confirm our existing beliefs. I quote,

In the long run, the more objective person will win against the more biased person." I wanted to be sure to talk a bit about the importance of being exposed to a diversity of viewpoints as well. John Stuart Mill wrote the following in his book, On Liberty. "The only way in which a human being can make some approach to knowing the whole of a subject is by hearing what can be said about it by persons of every variety of opinion,

and studying all modes in which it can be looked at by every character or mind. No wise man ever acquired his wisdom in any mode but this, nor is it in the nature of human intellect to become wise in any other manner." So on our own, we have just one viewpoint, which is our limitation as humans. But if we take a bunch of people and put them together that all have a similar limitation and put them together in a group, we get exposed to a diversity of opinions,

and hopefully move closer toward accuracy. On our own, it would be impossible to get exposed to such diversity of viewpoints. So we need people around us that will expose us to alternative viewpoints that challenge our own assumptions and help identify our blind spots. When properly thinking in bets, we've run through a number of questions to examine the accuracy of our beliefs. Questions such as, "Why might my belief not be true?"

What other evidence might be out there bearing on my belief? What sources of information could I have missed or minimized on the way to reaching my belief? What are the reasons someone else could have a different belief? What's their support? And why might they be right instead of me? What can also make the buddy system more difficult is that we naturally gravitate towards people who think like us. So while value investors pride themselves on being contrarian, we can fall prey to collaborating with others who have the same beliefs as us

and don't fully benefit from what a buddy system can offer when differing perspectives come together. Another important aspect of a buddy system is data sharing. We've all experienced a situation where two people gather information on the same event, and each person's interpretation of the event are dramatically different because they're informed by different facts and perspectives. This is known as the Raushman effect. Named after the 1950 cinematic classic, the Raushman effect

reminds us that we can't assume one version of a story is accurate or complete. To become an expert in a particular subject, one needs to collect as much information and data as possible in order to get a full picture and move closer to accuracy. Annie shares another poker example of the level of detail that a poker player gets into as to why they played a hand the way they did. When two expert poker players get together to trade views and opinions about the hands, the level of detail is extraordinary.

You have the positions of everyone acting in the hand, the size of the bets and the size of the pot, what they know about their opponents and how they've played previous hands, whether the other players have won or lost any of the recent hands, how many chips each person has, what their opponents know about themselves, the list goes on. What the experts recognize is the more detail you provide, the better assessment of decision quality you get. This

This reminds me of the example of how Ray Dalio would credibility weight the information he consumed based on who was sharing that information. In Dalio's words, I quote, "It is far better to weight the opinions of more capable decision makers more heavily than those of less capable decision makers." Robert Leonard : Let's take a quick break and hear from today's sponsors. Robert Leonard : Trust isn't just earned, it's demanded. Whether you're a startup founder navigating your first audit,

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All right, back to the show. So how do you determine who is capable of what? The most believable opinions are those of people who, one, have repeatedly and successfully accomplished the thing in question, and two, have demonstrated that they can logically explain the cause-effect relationships behind their conclusions. When believability weighting is done correctly and consistently, it is the fairest and most effective decision-making system. It not only produces the best outcomes, but also preserves alignment,

since even people who disagree with the decision will be able to get behind it." This is why we primarily try to interview asset managers with a track record of beating the market, as they've shown that they practice what they preach and likely have the most credibility out of anyone. Perhaps luck played a major role in some of their successes, but sometimes it's the best that we can do. While Dalio believes in credibility-weighting information, Annie believes that the accuracy of a statement should be evaluated independent of its source.

There's the well-known advice of "don't shoot the messenger" that comes from the example of the king of Armenia killing a messenger for delivering the unpleasant news that an enemy's troops were approaching, and this led to messengers no longer reporting important information. Annie encourages us not to disparage or ignore an idea just because you don't like who or where it came from. When we have a negative opinion about the person delivering the message,

we close our minds to what they're saying and miss out on the opportunity to learn. Likewise, if we hear an opinion from someone we like, we tend to be fairly open to it and just take on those opinions as well. She writes here, "Whether the situation involves facts, ideas, beliefs, opinions, or predictions, the substance of the information has merit separate from where it came from. If you're deciding the truth of whether the earth is round,

It doesn't matter if the idea came from your best friend or George Washington or Benito Mussolini. The accuracy of the statement should be evaluated independent of its source." End quote. Us investors have the luxury of seeing what stocks super investors are buying and selling, and it can be tempting to follow their moves and get into the names that others are. This can be a way to source investment ideas, but it should never be the sole reason you purchase a stock.

Even the best investors are likely to bat less than 50%. So there's a good chance that a stock, even in a super investor's portfolio, will not turn out well. And we never have the full context as to why an investor is buying or selling a name. Perhaps they have different motives for owning different positions. They might have a different investment objective than you. One question I like to ask myself when entering a stock is how would I react if the stock price fell by 50% after I bought it? This helps specifically

spark ideas as to why an investment can potentially go wrong and help me think through my reasoning for buying it. If the thought of the stock price falling worries me, then perhaps I don't know enough about the name to buy it today. If the idea of the stock price falling excites me because I can buy shares at a bargain, then perhaps I do understand the name well enough to initiate a position.

I'm as guilty as anyone when it comes to the liking bias. And when a specific investor says one thing, I need to consider how I would view that information if it came from a different source. The liking bias is something I certainly need to be more mindful of so I can properly assess the information I take in from different sources and not necessarily take certain things as gospel just because it came from a particular source, such as a really smart investor.

It's also helpful to remember that we're all biased. So even the super investors we all follow have their own biases and their own tendencies. And again, they do not bat 100%. They're going to make mistakes. And he also touches on potential conflicts of interest. So back in the 1960s, the scientific community was at odds about whether sugar or fat was the culprit in the increasing rates of heart disease.

In 1967, three Harvard scientists conducted a comprehensive review of the research to date, and it firmly pointed the finger at fat as the culprit. And their paper was influential in how hundreds of millions of people viewed their diets and proper eating habits by consuming more sugar and less fats. Decades later, it was found that a trade group representing the sugar industry had paid the three Harvard scientists to write the paper. None of these scientists are alive anymore.

But it's possible that if we could ask them, they likely would not have known that they were highly influenced by their own self-interest to defend the sugar industry. Since the conflict of interest wasn't disclosed in the paper, this prevented an accurate assessment of their findings, resulting in serious harm to the health of the nation. While this conflict of interest was financial, our brains also have built-in conflicts of interest that don't have to be tied to money.

We tend to interpret the world around us to confirm our existing beliefs and avoid having to admit to ignorance or error. We simply don't process information independent of the way we wish the world to be. I believe that the best value investors are natural skeptics. While skepticism might be considered a negative trait in someone who is generally disagreeable, they appreciate the role of differing opinions and actively search for reasons they could be wrong.

And skepticism can be uncomfortable and difficult, but thinking in bets demands the imperative of skepticism. As Richard Feynman said, if we don't lean over backwards to figure out where we could be wrong, we are going to make some pretty bad bets. I think that if we can put together a buddy system where you have somebody that is willing to challenge your viewpoints, you can have someone help you approach a topic with skepticism and use somebody else to play devil's advocate on a belief that you have.

This can make the concept of challenging your viewpoints more manageable and perhaps even fun if you create a culture where challenging viewpoints is encouraged. In the final chapter of the book, Annie explores how emotions play into our decision-making. She encourages us to bring our past or future selves into the equation to help put into perspective the significance of an event. She uses the example of imagining you got a flat tire on the side of a highway.

You don't have a jack to replace the tire and all of a sudden a thunderstorm hits and you're in the middle of nowhere. In the moment, we can get quite emotional and upset about this situation, understandably so. If you fast forward a year, that incident likely had no major impact on your life, your success, or your happiness. It turns into a funny story that you tell at the bar. Relating this concept to investing, in 2022, the S&P 500 and the broader market overall entered into bear market territory.

From peak to trough, the S&P fell by over 25%. This was a painful experience for many, if not most investors, as the value of their portfolios fell and it seems like they just couldn't catch a break for months straight. Looking back, it seems silly to have been concerned about such a market drop. If given the chance to go back in time, we would all go back and buy as many shares as we could of our favorite companies. When we look back at 2022 from the year 2042,

it's going to look like a tiny little blip that was totally irrelevant. It gets to this idea that just because something might feel painful in the moment, it might also have just little significance when zooming out and looking at the bigger picture. Putting ourselves in the future can help calm down our emotions that we feel in that moment and tap into the more rational parts of our brain. This is also why checking stock prices every day can be quite counterproductive

The day-to-day movements of the stock market are largely random and noise, and driven by factors that are irrelevant to the underlying business long-term. There are many companies in 2022 where the fundamentals were improving as they had for many years, but the price of the shares still declined. As a long-term investor, this is actually a good thing because you can buy more shares, but in the moment, it still feels like a bad break. Another poker concept that ties in well to investing is tilt.

Tilt can be a poker player's worst enemy. Tilt refers to when a player becomes emotionally unhinged in their decision-making because of the way things turned out. They can all of a sudden start playing the game differently and changing their strategy on the spot, which is totally irrational to do. The same thing happens in investing when emotions like fear, greed, or frustration take over, leading to impulsive trades, chasing performance,

or abandoning a sound strategy due to short-term outcomes. Just like a poker player on tilt might play overly aggressive after a bad beat, an investor might chase hot stocks or funds, assuming past performance will continue even when fundamentals don't support it. Or a poker player on tilt might fold too often out of fear, just as an investor might panic sell during a market correction, locking in losses instead of staying disciplined. Or we can also think about overconfidence.

A poker player on a hot streak might start playing too many hands, just as an investor who had a few successful stock picks might overestimate their skill and take on excessive risk. The best poker players manage tilt by staying disciplined, sticking to their strategy, and avoiding emotional decision-making. The best investors do the same by keeping a long-term perspective, following a well-defined strategy, and not letting short-term market moves dictate their decisions.

She also outlines the importance of thinking probabilistically. The future is uncertain, so we need to consider what decisions will lead to what potential outcomes and make our best guess at the probability of each of those future outcomes coming to fruition. This type of thinking applies to just so many areas of life, and it especially applies in business and investing. By working with a group of people on the future potential outcomes, we're better able to get an idea of what outcomes are even possible

and what might be an appropriate probability of each outcome. Thinking probabilistically can also help us avoid unproductive regret when a particular future happens. We might do everything right when picking a particular stock, but the reality is that even the best processes will have their fair share of losers in a portfolio. By understanding that most bets won't have a 99% chance of success or more, we won't fall prey to resulting or hindsight bias

in which we gloss over the futures that did not occur and behave as if that the one that did occur must have been inevitable. She then shares a couple of more tools we can add to our toolkit for decision-making, which includes backcasting and premortems. Backcasting involves working backwards from a goal and determining the best plan of action to achieve that goal. It turns out that our minds are better at working backwards in time rather than working forwards. So Annie writes here,

When we identify the goal and work backwards from there to quote unquote, remember how we got there, the research shows that we do better. In a Harvard Business Review article, decision scientist Gary Klein summarized the results of a 1989 experiment. They found that perspective hindsight, which means that imagining that an event has already occurred, increases the ability to correctly identify reasons for future outcomes by 30%, end quote.

So this method of backcasting, it can enable us to better identify strategies, tactics, and actions that need to be implemented to get the goal we desire, and can help us identify when there are low probability events that must occur to reach that goal, meaning that we can tweak our strategies to maximize our chances of success during those low probability events. So let's say an investor wants to earn a 15% return over the next five years.

Well, some things I would personally do to achieve that goal would be to only invest in companies with a return on capital of at least 12%, preferably 15%. I would hold minimal cash that earns a much lower yield than 15%. And I would look for companies that are likely to increase their intrinsic value by at least 12% to 15% per year. The other tool that Annie shared is premortems. This is the process of working backward from a negative future instead of a positive one.

It reminds me of the Mugger quote, all I want to do is know where I'm going to die, so I'll never go there. As investors, it's easy to look at the positive side, all the reasons that everything's going to go right for a business and all the potential upside. It's just so easy to overestimate the probability of good things happening because instinctively, that's the scenario we want to play out. It's critical to also consider what could go wrong. What could make an investment a complete failure?

Once we ask ourselves why an investment can go wrong, we can recognize the key mistakes that we can make along the way and help identify potential obstacles in the way of a business. When you visualize an investment going badly, we can likely come up with good reasons as to why it went wrong. Backcasting and premortems can be useful tools in thinking probabilistically and thinking in bets rather than thinking in terms of black and white going into an investment.

I also wanted to be sure to touch on the topic of quitting, which relates to Annie's other book titled Quit: The Power of Knowing When to Walk Away. I love this topic because for investing, it ties right into selling a position. I believe that knowing when to sell a stock is one of the most difficult parts of investing because once we own something, we have all these biases and emotions that play into our position. For example, when we've done all this research on a name,

There might be some sunk cost fallacy at play because we don't want to feel like we wasted all this time researching the company. There's the endowment effect, which is the bias that leads to people valuing that which they own higher than identical items that they don't own. And there could also be the liking bias because we've listened to a number of the interviews and earnings calls and come around to really liking the management team, for example, for whatever reason. Broadly, I personally have three reasons for selling.

The first is that the thesis fundamentally has changed and the company's prospects are no longer what I thought it would be. Second is that the valuation becomes egregiously overpriced. Say if the multiple tends to be around 20 to 30 for a company, then I would consider selling if the earnings multiple got to say over 50 or 60 times normalized earnings, which is quite rare, but still a possibility. The third reason for selling is if I find an idea that is significantly better,

And the bar has to be quite high for trading around positions because I don't want to turn over my portfolio too frequently and incur taxes.

Now, Annie developed her CAIL criteria framework as a structured way to decide in advance when to walk away from a commitment before our emotional biases take over. The idea is to pre-define specific conditions that if met, trigger an automatic decision to quit. So in this case, selling a stock. This helps prevent the common pitfalls of loss aversion, sunk cost fallacy, and overconfidence.

This can be applied to investing by setting predefined rules to exit a position. These predefined rules could be related to a fundamental deterioration in the fundamentals, a change in the management or strategic direction that no longer aligns with your investment thesis, or an opportunity comes up with a better forward return. The difficult part can be when it's a bit of a judgment call, of course. It might be easy to say that you'll exit when the fundamentals deteriorate, but what does that really mean?

You can set up a process where growth slows by a certain amount or margins contract by a certain level. Then you'll exit the position, preventing our emotions and biases from playing a role. One thing I've realized is that all great businesses go through headwinds. The challenge is determining whether those headwinds are temporary or have permanently impaired the business. Inferior performance is to be expected from time to time, but I find it helpful to give a business

a limit to underperforming. Perhaps we can tolerate four to six quarters of lackluster performance before they turn things around, but three years or more for me might be a bit of a stretch and time to move on from a position. Another aspect of the kill criteria is that it can be dynamic, meaning that you have the ability to update your criteria to sell as new information arises. So let's say for Dino Polska, which I own, I initially had

let's say a kill criteria that if their growth in new stores goes below 10% per annum, then I would sell the position. Well, recently they've had slowing growth in stores, but a big reason for that is they were investing in building new distribution centers and paying down debt to sort of prepare for that next leg up of growth. If you were just looking at the store growth, then you might assume that they were reaching their maturity stage of their life cycle. But given the additional context and information,

I expected that the growth would pick back up and they would continue to reinvest back into growth. So the kill criteria is really dynamic. Remember that investing like life is really one long game. And there are going to be a lot of times where things just don't go your way, even after making the best possible bets. We'll be better off by keeping in mind that we'll never be sure of the future and that attempting to be right every time is an impossible job. Our goal as value investors is

should be to inch our way closer to thinking more objectively and being more mindful of the biases hardwired into us. Remember that even the best investors bat something like 50%, so losses are simply a part of the journey and something that we need to learn to embrace. I hope you enjoyed today's episode on Thinking and Bets by Annie Duke. I've really enjoyed going through the book and putting together this episode for our listeners. So with that, thank you for your time and attention today, and I hope to see you again next week.

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