Base Rates + Outside/Inside View Mental Model

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Executive Summary Of Base Rates + Inside/Outside View Mental Model:

If you only have three minutes, this introductory section will get you up to speed on the base rates + inside / outside view mental model.

This is a real, not fictional, story: there’s this one small shack along a major road near where I live. The “inside view” is that it would seem to be in a reasonable location for grab-n-go junk food – right across the street from a large educational institution, and nearby a few entertainment destinations that draw lots of school-aged kids and their tired parents – but it seems like no food establishment ever manages to stay in business there for more than a few years.  As such, the “outside view” is that there is a high “base rate” of failure in that location.  So I wouldn’t want to attempt opening a fast-food joint there, let alone buy the building!

The concept in one sentence:

the statistical frequency of something over a large sample size is known as the “base rate,” and it serves as a useful starting point on which to anchor our evaluations.

A formal definition: Michael Mauboussin, in “ The Success Equation ( TSE review + notes), defines the base rate with the following example:

“If 85% of the taxicabs in a city are green, then 85% is the base rate.  Absent any other information, you can assume that whenever you see a taxicab[,] there’s an 85% chance that it will be green.”

Key takeaways/applications: when evaluating situations in our lives or work, we have a tendency to focus only on the factors we see – the “inside view” – which often excludes important information thanks to selective perception; we can improve our probabilisticoutlooks if we incorporate the “outside view” by basing our analysis off the “base rate.”

Three brief examples of base rates:

I don’t think Munger meant it literally, but let’s do it.  Base rates can help us apply a margin of safety to our recreational activities: one of the best pieces of advice in Laurence Gonzales’ “ Deep Survival ( DpSv review + notes) is a recommendation to read published accident reports and statistics for your specific hobby (climbing, surfing, skiing, etc) to understand how and when dangerous situations can crop up.  Gonzales notes the example of some climbers who failed to take into account the high likelihood of lightning on mountain peaks circa 3 PM on summer afternoons, often despite previously clear/beautiful weather, to deadly consequences.  It’s a literal interpretation of Munger’s advice:

“All I want to know is where I’m going to die so I’ll never go there.”

Don’t forget the missing planes.  A knowledge of base rates helps develop understanding of counterfactuals and prior probabilities, allowing us to be a filter, not a sponge and separate good advice from bad – “signal” from “noise” – when we encounter new information.  Phil Rosenzweig points this out compellingly in “ The Halo Effect ( Halo review + notes), explaining how many popular business case studies fail to take survivorship bias into account.

Please don’t schedule my parole hearing then, I beg you.  Looking at base rates as they relate to our own behavior can help us craft more effective structural problem solving approaches to reach our goals, ranging from increasing activation energy for undesired activities (not keeping ice cream in the freezer, ‘cuz we’ll eat it!) to creating rules that we make a habit of following (“I won’t take phone calls right before lunch.”)

If this sounds interesting/applicable in your life, keep reading for deeper understanding and unexpected applications.

However, if this doesn’t sound like something you need to learn right now, no worries!  There’s plenty of other content on Poor Ash’s Almanack that might suit your needs. Instead, consider checking out our discussion of the n-order impacts,compounding, or sunk costs mental models, or our reviews of great books like “Zero To One” by Peter Thiel ( Z21 review + notes), “ Ordinary Men” by Christopher Browning ( OrdM review + notes), or “ Internal Time” by Till Roenneberg ( IntTm review + notes).

A Deeper Look At The Base Rates + Inside/Outside View Mental Model

“Unrealistic optimism is at its most extreme in the context of marriage.  In recent studies, for example, people have been shown to have an accurate sense of the likelihood that other people will get divorced (about 50 percent).  

But recall the fact that they have an absurdly optimistic sense of the likelihood that they themselves will get divorced.  It’s worth repeating the key finding: nearly 100 percent of people believe that they are certain or almost certain not to get divorced!

It is in these circumstances, and in part for that reason, that people are immensely reluctant to make prenuptial agreements[,] believing that divorce is unlikely, and fearing that such agreements will spoil the mood…”

That quote, from Cass Sunstein and Richard Thaler on page 226 of “ Nudge” NDGE review + notes) – a phenomenal mental models book – powerfully illustrates how the “inside view” – i.e., the story we construct based on the evidence we see – can diverge wildly from the “outside view,” i.e. the statistical “base rate” that applies to the situation we find ourselves in.

The obliviousness of newlyweds is a clear case of overoptimism: of all couples that estimate there’s only a 10% chance they will get divorced, there’s actually a 50% chance they will end up divorced.  (Depressingly, we don’t learn: the statistics for repeat marriages are not much better, and maybe even worse, according to research I’ve seen.)

Base Rates + Inside/Outside View Salience / Vividness x Margin of Safety x Disaggregation

Base rates can be helpful because they’re cold, hard data that counter  salience / vividness bias.  While that’s a mental model worth internalizing thoroughly, the short version is that we perceive danger with emotion, not reason.

We often tend to overestimate “scary” risks (like murder, or Ebola) while remaining blase about the real killers.  Here’s data sourced from the CDC and other credible entities on the base rates of causes of death:

U.S. Deaths from Heart DIsease (2016) ~ 630,000
U.S. Deaths from Suicide (2016) ~ 43,000
U.S. Deaths from Car Crashes (2016) ~ 37,000
U.S. Deaths from Flu (average year) ~27,500
U.S. Deaths from Homicide (2016) ~ 17,000
U.S. Deaths from Airline Crashes (CUMULATIVE, Feb 2009 – June 2018) 46
U.S. Deaths from Ebola (2014) 2

Of course, as we’ll get into, it’s important to use the “right” base rate – for example, your likelihood of dying of the flu is meaningfully higher if you’re elderly or have a compromised immune system. 

Nonetheless, focusing on “base rates” can help us make more appropriate decisions about what risks are worth worrying about and mitigating, or which opportunities are worth pursuing and which are long shots without enough payoff to have an expected value higher than the  opportunity cost.

As usual, this is often discussed in a probabilistic business/prediction/statistical analysis context, as in Mauboussin’s “ The Success Equation ( TSE review + notes) or Tetlock’s “ Superforecasting ( SF review + notes), which are excellent books that thoroughly explore those angles.  (Ellenberg’s “ How Not To Be Wrong ( HNW review + notes) focuses on it less, but it’s still included.)  So, as usual, I’ll present a more novel take here.Sources: CDC.govCDC.govNHTSA.gov

Let’s get a little more technica: what is the appropriate base rate to use?

Many novice hikers tend to worry about “scary” risks like wild animals, but “base rate” statistics indicate that the real risks are much more pedantic: dehydration and hypothermia (big ones!), as well as falls and getting lost. With that in mind, carrying essential safety gear like a light source, extra water, a compass, first aid, and waterproof/heat-trapping coverings (such as clothing or, as pictured, a lightweight, inexpensive space blanket) can meaningfully reduce your risk of injury or death while enjoying the outdoors.

Since it’s scary and salient and I’m going to bore you to death if I talk about coronary artery disease and the dietary steps that can reduce your risk, let’s go back to our lightning example.  How likely is it that you will be struck by lightning?  You could, for example, start with the number of people who are struck by lightning in the U.S. every year – NOAA data seems to estimate this at circa-500 (with about 10% of those strikes fatal, and the rest generally resulting in long-term neurological damage, which is also bad).  

So, on any given day, 500 ÷ 365 = ~1.5 people are struck by lightning.  There are 300 million people in America, so your chance of being struck on any given day is 1-in-50-million… i.e., too small to worry about.

But that’s a profoundly unhelpful base rate: the number of people who are struck by lightning in a properly grounded building or a car with the windows closed probably approximates zero.  NOAA data indicates – unsurprisingly – that everyone killed by lightning was outside; it’s also not a stretch to imagine that there was also a storm (they weren’t struck from clear blue sky).  So, our denominator is wrong – it shouldn’t be “all Americans,” but rather “all Americans who happen to be outside during a thunderstorm.”

Philip Tetlock discusses this topic in “ Superforecasting ( SF review + notes), explaining that the eponymous “superforecasters” integrate outside-view, base-rate thinking into their forecasting process, with an emphasis on using the right base rate via a process of disaggregation.

Another example of salience bias intersecting with base rates and margin of safety: it is possible to reduce your risk of being attacked by a bear to near-zero, even if you are an avid outdoorsman. Black bears are only very rarely aggressive, whereas grizzly bears are frequently aggressive, so your first step is to stay away from grizzly bear range (which still offers plenty of recreational opportunity). Research further demonstrates that the “base rate” of bear attacks can be dramatically reduced if you follow some easy steps such as: 1) not approaching bears, 2) carrying bear spray (which has a much higher “base rate” of successful deterrence than guns), and 3) securing all food in a bearproof canister stored away from your tent.  Image source: National Park Service

Given how few people are fatally struck by lightning, the sample size is too small to really conclude a lot of useful further lessons from looking at this sort of data.   Inversionon the other hand, can be helpful: let’s flip the conditional probability around.  Rather than focusing on where people were, given that they were struck by lightning, what if we focused on where lightning strikes – or, even more specifically, where lightning strikes and at what times of day?

That’s exactly the sort of analysis Gonzales touches on in various places in “ Deep Survival ( DpSv review + notes) – it turns out that afternoon lightning is quite common high up on mountains in the summer.  Of course, very few people out of all total Americans are up on the tops of fourteeners during summer afternoon storms, so not very many people die – but if you’re planning to be there at that location, season, and time of day, your “base rate” of being struck is orders of magnitude higher than it would be generally.

It is difficult, of course, to come up with a precise estimation, but it doesn’t matter because this is a precision vs. accuracy type situation: any activity that gives me a relatively meaningful chance of dying or sustaining permanent, irreversible injury, with a low opportunity cost delta to my next-best alternative (going hiking at another time in the year when storms are rare, or in another location where, again, storms are rare), would seem to be a pretty easy call.

If you conduct this sort of probabilistic analysis, it does become clear that a high-altitude backpacking trip this summer in the Colorado Rockies (which I was originally planning) is probably not a good idea.

So, a key takeaway is that while precise and quantified base rates can be helpful, they’re not absolutely necessary.  I like/love this quote from a colonial governor in John Lewis Gaddis’s 300-page masterpiece On Grand Strategy (OGS review + notes):

“I imagined, like most young beginners, that… I should be able to make a mighty change in the face of affairs, but a little experience of the people… has absolutely cur[e]d me of this mistake.”

See also, of course, Buffett/Munger’s commentary on their poor track record of changing people’s minds.  You don’t need to know exactly how unlikely it is that you’ll be able to change someone’s mind to know that it’s not the best approach to rely upon.

Base Rates + Inside/Outside View Humans vs. Econs = Planner-Doer / Hyperbolic Discounting

All of my good ideas are stolen from Thaler (well, most of them, anyway.)  While Nudge is wonderful, so is “ Misbehaving ( M review + notes), my favorite book of all time.

In Misbehaving, Thaler presents a hilarious story about cashews at a dinner party that violates classical “rational-actor” economic theory and demonstrates that we’re humans, not econs.  (I won’t spoil the story here – you gotta read the book for that.)

Thaler extends this theme into the idea of hyperbolic discounting, presenting a “ planner-doermodel that applies the idea of local vs. global optimization to our current and future decisions.  This is obviously important in the context of life decisions (as Thaler and Sunstein note above), but it’s important in more trivial contexts too.

… like the hot dog stand, the Costco example is not theoretical. Not pictured: the two bottles of Raspberry Chipotle sauce I bought a decade ago around the holidays for spreading on brie and crackers.  Those bottles are… uh… probably still in the pantry somewhere.

You ever shopped at, say, Costco, while you were hungry?  And come home bearing fifteen five-pound bags and 48-ounce boxes of various goodies?  Which… proceeded to sit in your pantry and freezer for a year before you were able to get over the sunk costs, admit you were never going eat them, and throw them away?  Well, that’s an example of the hot-cold empathy gap – our tendency to consistently overestimate (when we’re hungry) how much food we will want when we’re nothungry, a sort of recency bias schema bottleneck, if you will.

As with many things, admitting we have a problem is half the solution; knowing that we have a tendency to overpurchase at Costco – a “base rate,” or “outside view,” – we can therefore adjust our “inside view” (what we want now).  Yeah, that giant bag of veggie straws may look tempting*, but so did that value-pack of croutons that’s still going stale…

*Said no one ever.

Jokes aside: in “ The Happiness Advantage – a serious psychology book by Shawn Achor that drives home the power of agency ( THA review + notes) – Achor implicitly discusses base rates as an underlying component of behavioral modification.  If we notice that we’re consistently not achieving our goals, that may be a sign that either our goals need to be changed, or we need to reduce the activation energy between us and our goals.

Application/Impact: from contexts ranging from trivial (learning guitar) to vitally important (starting a business, choosing a spouse), knowing the appropriate “base rate” – whether that is the statistical likelihood that someone in our position will succeed/fail, or our own likelihood based on historical experience of actually doing something we plan to do – can help us make better decisions based on more realistic information than the limited amount we can immediately see.  If you want to explore this in more detail, check out the Bayesian reasoning / “be a filter, not a sponge mental model.

Base Rates x (Marginal) Utility

I’ll keep this last one short, since we’ve already covered a lot: one old saw that I mention a lot around here goes something like this:

“How do you get good judgment?”

“Experience.”

“How do you get experience?”

“Bad judgment!”

This is why reading is so powerful: it allows us to, as John Lewis Gaddis mentions in “ The Landscape of History ( LandH review + notes), “experience vicariously what we can’t experience directly: a wider view.”

Thaler’s Misbehaving includes a lot of analysis on the idea of (marginal) utility: an important model you should read about more in depth, but (summarily) the idea that the enjoyment we get out of things follows a declining curve; it’s nonlinear.  As David Einhorn might say,

Two Jelly Donuts are an indulgent breakfast.

Twelve Jelly Donuts is fraternity pledge hazing.

It is, of course, sometimes difficult to know today what it is we will want tomorrow, let alone in five or ten years.  That’s where “base rates” can come in – we all unquestionably have our own idiosyncratic preferences, tendencies, and desires, but we’re all also human.  Therefore, it can be helpful to contextualize our “inside view” of what we want out of life with the “outside view” of those who’ve gone before us.

Pillemer’s “30 Lessons for Living” is a unique read. Some of the takeaways are “predictable” – but maybe that’s the point. Common sense isn’t so common!

Research, such as that presented in Shawn Achor’s “ The Happiness Advantage ( THA review + notes) or Karl Pillemer’s “30 Lessons for Living” (30L review), tends to find that humans – generally – derive less satisfaction than they expect from reaching financial or material milestones, and far more than they realize or anticipate from a sense of meaning/purpose/ agency as well as social connection, particularly with close friends and family members.

The “experienced citizens” surveyed by Pillemer rarely expressed that more money would have made them happier: instead, it’s better relationships with their kids, having the courage to do things for themselves that seemed risky, etc.

Of course, as with the earlier lightning example, it’s important to refine the “base rate” down to the appropriate category.  Does the same hold true for “people like me” – i.e., ambitious, highly educated individuals in the world of finance and business?

Admittedly I have a smaller sample size to work from, but the answer seems to be “absolutely” – from talking to older (i.e. 40s+) fund managers and business professionals with enough experience to reflect back on their careers, they absolutely echo those lessons.

I’ve gotten to the point where I’ve pretty fully internalized those lessons, but certainly, seeking and appreciating this “base rate” or “outside view” helped me come to a more accurate life plan.

Application/Impact: As Tavris/Aronson note in “ Mistakes were Made (but not by me) ( MwM review + notes), it can be easy to ignore the “outside view” and pretend that cognitive biases, self-justification, or other traits intrinsic to human nature are merely “other people problems.”

While that may be true sometimes, using the average human experience as your “base rate”  will likely lead to more informed and accurate predictions for maximizing your own utility rather than only using the “inside view.”