Simple Decision Making Game Plan Example
Possible outcomes
Outcome A: Small profit
Outcome B: Moderate profit
Outcome C: Large profit
Outcome D: Enormous profit
Potential payoffs
Payoff A: $100
Payoff B: $1000
Payoff C: $10,000
Payoff D: $100,000
Assigned probabilities
Chance of A: 100%
Chance of B: 50%
Chance of C: 5%
Chance of D: 1%
Expected value calculations
A: $100 x 100% = $100
B: $1000 x 50% = $500
C: $10,000 x 5% = $1000
D: $100,000 x 1% = $10,000
Compare the expected payoffs for each choice
Choice B and C have equal expected payoffs if playing an infinite game with repeating iterations. If there is only a single iteration in a finite game and two outcomes have similar expected value choose the one with higher odds.
Choice D beats B and C by 20x. If you have 100 iterations to play choice D the magnitude of the pay out trumps the low probability over 1 iteration.
If you cannot survive the game if you dip under $100 in the next turn then you must choose choice A.
Remember the first rule is to survive to play again.
If you blow up in your health, wealth or relationships it is very hard to rebuild. This is because of something called volatility decay. If you lose 50% of an investment, say $1000 to $500, it then requires a 100% gain to get back to break even ($500 to $1000 or 100%/$500 profit).
To hedge against volatility decay and follow the most important rule, always keep a large margin of safety.
