What Is a Decision Tree?

A decision tree is a diagram or chart that helps determine a course of action or show a statistical probability. The chart is called a decision tree due to its resemblance to the namesake plant, usually outlined as an upright or a horizontal diagram that branches out. Starting from the decision itself (called a "node"), each "branch" of the decision tree represents a possible decision, outcome, or reaction. The furthest branches on the tree represent the end results of a certain decision pathway and are called the "leaves".

People use decision trees to clarify, map out, and find an answer to a complex problem. Decision trees are frequently employed in determining a course of action in finance, investing, or business. In mathematics, decision trees are also referred to as tree diagrams.

Key Takeaways

  • A decision tree is a diagram or chart that helps determine a course of action or show a statistical probability.
  • Each branch of the decision tree represents a possible decision, outcome, or reaction. The furthest branches on the tree represent the end results of a certain decision pathway.
  • People use decision trees in a variety of situations, such as determining a course of action for a complex finance or business decision.
  • In the decision tree, each end result has an assigned risk and reward weight or number. If a person uses a decision tree to make a decision, they can look at each final outcome and assess the benefits and drawbacks.
  • However, using a decision tree to extrapolate the outcomes of a decision can also overcomplicate the matter at hand and lead to analysis paralysis.

How a Decision Tree Works

A decision tree is a graphical depiction of a decision and every potential outcome or result of making that decision. Individuals deploy decision trees in a variety of situations, from something simple and personal ("Should I go out for dinner?") to more complex industrial, scientific, or microeconomic undertakings.

By displaying a sequence of steps, decision trees give people an effective and easy way to visualize and understand the potential effects of a decision and its range of possible outcomes. The decision tree also helps people identify every potential option and weigh each course of action against the risks and rewards that each option can yield.

An organization may deploy decision trees as a kind of decision support system. The structured model allows the reader of the chart to see how and why one choice may lead to the next, with the use of the branches indicating mutually exclusive options. The structure allows users to take a problem with multiple possible solutions and to display those solutions in a simple, easy-to-understand format that also shows the relationship between different events or decisions.

In the decision tree, each end result has an assigned risk and reward weight or number. If a person uses a decision tree to make a decision, they can look at each final outcome and assess the benefits and drawbacks. The tree itself can span as long or as short as needed in order to come to a proper conclusion.

Decision trees include three components: the decision itself (or "node"), the potential decisions ("branches"), and the potential outcomes of each decision (the "leaves").

How to Make a Decision Tree

To make a decision tree, start with a specific decision that needs to be made. You can draw a small square at the far left of the eventual tree to represent the initial decision. Then, draw lines outward from the box; each line moves from left to right, representing a potential option. Alternatively, you can start with a square at the top of a page or screen, and draw the lines downward.

At the end of each line or option, analyze the results. If the result of an option is a new decision, draw a box at the end of that line, and then draw new lines out of that decision, representing the new options, and labeling them accordingly. If the result of an option is unclear, draw a circle at the end of the line, which denotes potential risk. If an option results in a decision, leave that line blank. You continue to expand until every line reaches an endpoint, meaning you've covered every choice or outcome. Draw a triangle to indicate the endpoint.

Advantages and Disadvantages of Decision Trees

In the field of decision analysis, decision trees and other tools like influence diagrams are incredibly useful tools to lend a systemic and visual approach to an otherwise complex decision. Rather than thinking abstractly about an upcoming business decision, decision trees can be used as a starting point for thinking through it.

On the flip side, extrapolating the outcomes of a decision can also overcomplicate the matter at hand and lead to analysis paralysis. Of course, there are drawbacks to decision trees too: there isn't always a good way to represent overlapping outcomes, representing uncertainty, or simply if there are too many decisions to consider. It's best to use decision trees when there are a few clear paths to take.

Pros
  • Visual and systematic approach to breaking down decision making

  • Clearly outlines the long-term impacts of making certain decisions

  • Decision trees can also express trade-offs and probabilities

Cons
  • Over-complication of a decision can lead to analysis paralysis

  • Decision trees can be overly complex with too many pathways

  • Linked outcomes and uncertainty are hard to represent visually

Example of a Decision Tree

For example, a software company may want to think about the pros and cons of what to focus their next effort on. New features on an existing app? Coming up with a new product? There are a few ways they could use a decision tree, depending on the audience they are targeting, the amount of manpower or financial investment needed for each path, and the outcomes if each route is a success or a failure.

An example of a personal decision to use a decision tree for may be deciding whether or not you want to enter into a lawsuit with someone, and your chances of getting a judgment in your favor. Alternatively, you can map out what would happen if the lawsuit got extended, and what would happen in the case of a win or a loss for your side, including the legal fees or potential payoff for each decision.

The Bottom Line

Decision trees can be very useful tools for individuals, investors, and other business professionals that need a visual way to break down a complex decision. Although they have their drawbacks--no model is perfect, after all--decision trees are good starting points to represent the end results of a certain decision pathway.