Probability Series #3: The Mental Technique Jeff Bezos Uses (That Investors Can Use Too)

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Great decisions tend to look easy in hindsight. Through the lens of history, a hugely successful call — like starting a company that changes the world, for example — appears to be an obvious move.

But big decisions always look easier after they’ve worked out. Making the call in the moment can be tough. There is a useful mental technique that applies here — a probability technique — that Jeff Bezos used to make his big call on starting Amazon.

Investors can use this technique too.

In a 2010 speech at Princeton, his alma mater, Bezos revealed the thinking that led him to quit his Wall Street job and start Amazon in mid-1994:

“I came across the fact that Web usage was growing at 2,300 percent per year. I’d never seen or heard of anything that grew that fast, and the idea of building an online bookstore with millions of titles was very exciting to me.”

This was not an easy decision. In the mid-1990s, betting everything on an internet startup was a crazy idea. (Ten years later, vocal financial journalists were still calling Bezos crazy.)

Bezos was 30 years old in 1994. He wasn’t wealthy, but he had a great job at a successful Wall Street hedge fund, D.E. Shaw & Co. He was a senior vice president, well respected by his peers, and on his way to making hundreds of thousands or even millions of dollars per year.

Bezos spent a lot of time thinking about the decision of whether to quit and found Amazon. He turned it over and over in his mind. He walked around the city with his boss, the founder of D.E. Shaw, and asked his opinion.

(His boss, not surprisingly, told Bezos he thought he should stay.)

To get Amazon started, Bezos took a big chunk of money from his parents, Jackie and Mike Bezos. In 1995 they gave him nearly $250,000.

Before he took the money, he double-checked to make sure it would still be okay if he failed … so he could “still come home for Thanksgiving” if Amazon didn’t work.

Again, it looks like an easy call in hindsight. But in the beginning, it was anything but. Bezos was 30 years old … far from wealthy … and well on the path to a successful career on Wall Street. So why pack everything into a car, drive across the country, and bet his whole life on a dream?

Bezos later explained the mental technique he used — the “Regret Minimization Framework.”

Here is Bezos in his own words, via an interview with the Academy of Achievement, on why he chose to start Amazon (and take a big risk instead of keeping his Wall Street Job):

“I wanted to project myself forward to age 80 and say, ‘OK, I’m looking back on my life. I want to minimize the number of regrets I have’ … and I knew that when I was 80, I was not going to regret having tried this. I was not going to regret trying to participate in this thing called the Internet that I thought was going to be a really big deal. I knew that if I failed, I wouldn’t regret that … But I knew the one thing I might regret is not ever having tried. I knew that that would haunt me every day.”

To use the Regret Minimization Framework as a mental technique, you start by asking one question: “What is the Path of Least Regret?”

The Regret Minimization Framework involves projecting forward to a future image of yourself … and then imagining the different scenarios that could happen, and the different ways things could play out.

Minimizing regret then becomes a matter of avoiding the worst-case scenario in terms of “what if” — trying to avoid the risk of asking yourself over and over through the years, “What if I had done X?”

It can also mean looking at the probability of each scenario — from best case to worse case — and then taking steps to avoid the worst outcome.

Bezos knew if he didn’t take a risk and start Amazon, the “what if” question would have stayed in the back of his mind for the rest of his life. That question would have eroded his quality of life, possibly well into old age. He thus faced a risk either way — not taking a risk was another form of risk.

The power of the Regret Minimization Framework is also backed by scientific research.

In the mid-1990s — at almost the same time Bezos started Amazon — the Cornell University researchers Thomas Gilovich and Victoria Husted Medvec produced a study titled “The Experience of Regret: What, When, and Why.” You can read the paper here.

The paper looks at the reasons why “actions, or errors of commission, generate more regret in the short term; but inactions, or errors of omission, produce more regret in the long run.”

In 2011, Mike Morrison and Neal J. Roese conducted another psychology study. This one was called “Regrets of the Typical American” and reported the following:

“Results showed inaction regrets lasted longer than action regrets, and that greater loss severity corresponded to more inaction regrets.”

This dovetails nicely with what we know about how the human brain works.

As Nobel-prize winning research has shown — and as we have pointed out many times — investors tend to be risk-seeking when it comes to losses and risk-averse when it comes to gains.

That configuration is exactly backward! Scientific studies and the real world show that the path of inaction is often the one that creates regret.

Inaction in the presence of a growing loss can lead to thoughts of “What if I hadn’t lost so much?” for years or decades afterward … while being too quick to take a profit — not letting the upside play itself out — can lead to years or decades of wondering, “What if I hadn’t missed out?”

For investors, the Regret Minimization Framework means seeking “the path of least regret” in both cases. That means cutting against the grain of natural instinct in two ways:

First, by taking losses when they are still small and manageable (rather than experiencing the regrettable pain of a large loss);

And second, by letting upside opportunities develop to full strength (rather than experiencing the regret of missing a multi-month or even multi-year trend).

Here’s to an investment life with no regrets!