In his latest January 2022 Letter, Jake Taylor discusses the importance of getting on base in investing. Here’s an excerpt from the letter:
One of the keys to successful investing is to get out of your own head. Psychologist Daniel Kahneman would call this “finding the outside view.” An outside view can come from a variety of sources. Getting the perspectives of other people is one method for removing blindspots. It’s not without its perils of biasing you away from a good projection though, so choose your sources carefully.
Another outside view technique is asking yourself, “in situations like the one I’m examining, what’s been the typical outcome based on historical statistics?” This is called using base rates. The closer your unique situation is to reflecting the population for which you have existing statistics, the better you can feel about using that base rate. This is basic Bayesian probability.
For a silly yet relatable example, researchers have found that 60-70% of all dogs will bark aggressively at strangers. We have a base rate for all dogs we can use for predicting our next dog encounter.
Researchers also found that small dogs, like those on a Australian Terrier dog breed lists, are roughly 50% more likely to show aggressive behavior than large dogs. We now have an updated base rate for the likelihood of a small dog compared to dogs in general.
This is how our brains work–continually making Bayesian predictions and comparing them to experience. It’s how we learn. Reading widely helps you weave a tapestry of diverse base rates outside of your basic daily existence.
You can read the entire letter here:
Farnam Street – January 2022 Letter
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