I spend a lot of time looking at possibilities of how our future may develop and second-guessing some of the decisions we made along the way. It is not uncommon for me to spend hours discussing and analyzing the potential outcomes of each decision with my wife. Thankfully, she is patient and receptive of these mental exercises.
The problem is that our decision-making approach is flawed!
Let’s face it – we are not completely rational beings. We do not compute decision outcomes based on binary code using 0’s and 1’s. Sure, we could apply some decision quality practices to make better and informed decisions. We can create elaborate decision trees with A/B, Yes/No paths. We can even apply weight to decision paths and turn them into mathematical equations.
Also, don’t forget the old two-column method of listing pros and cons. Again, a lot of time, energy, and analysis can be used to weigh each item to arrive at what seems like a reasonable conclusion.
Bottom line – we have cognitive biases, and they affect the quality of our decision-making process.
One of my personal challenges is the confirmation bias: “The tendency to search for, interpret, focus on, and remember information in a way that confirms one’s preconceptions.” This definitely explains my infatuation with reading personal finance blogs, magazines, and books!
Perhaps the biggest challenge for me is the outcome bias: “The tendency to judge a decision by its eventual outcome instead of based on the quality of the decision at the time it was made.” This has probably been the motivating factor that drives my passion toward achieving the end goal of Financial Independence – often overlooking many decisions to consider along the way.
The Reality of Biases
Emotions and biases are a significant component of our personality. These have been formed by our environment, experiences, education, culture, etc. There is just no denying it – we are emotional creatures and make decisions based on faulty data, emotions, and biases. I like to break this down into a simple model – Fear/Pain versus Greed/Pleasure.
Let’s look at some examples:
Pretend you are at a shopping mall looking for a TV and a blender. If you become aware that that you could save $10 off a $25 kitchen blender that is 5 miles away, would you drive to get it? How about $10 off a $1,500 TV that is also 5 miles away? Would you drive for the blender but not for the TV?
Either decision will save you $10 for driving 5 miles. Maybe you look at the cost of your time, your hourly rate, what it would cost in gas, etc., to make that decision. Perhaps the decision is more swayed by the fact that you would save 40% on the blender but less than 1% on the cost of the TV. Either way, it is still $10 and should make no difference. This is called the framing effect bias.
You are trying to make some decisions on what investments to choose for your work place retirement account. One investment has a 70% to 80% chance of making money while the other has a 20% to 30% chance of losing money. Which would you choose?
If I explained it correctly – they are both the same mathematically, yet one looks at the investment from a perspective of optimism (greed/pleasure) while the other is from the loss (fear/pain) perspective. Studies have shown that we are at a multiple of 3 to 5 times more likely to avoid the loss (pain) than reach for the gain (pleasure). This is a classic loss aversion behavior.
How the heck do you get around this kind of illogical behavior?
Some Approaches We Follow
- Look at the opposite of each situation. If you are trying to make a decision about a choice you should make, take a completely different perspective.
Imagine the exact opposite of what the decision would be if you did not go with it. Take a few minutes to visualize how that would look from your perspective and perhaps from your spouse’s viewpoint. Sometimes this gives us some new insights into a decision that we might not have considered before, helping to eliminate several of our biases.
- Stop, breathe, and get into the present moment. Take some time to sit in a comfortable chair, and breathe 5 large breaths in and out. Pause after each breath, at the end of each inhale, and finally at the end of each exhale. Your mind, of course, will wander – it will take some practice, but it is worth the effort. Simply try to clear out the internal talk and clutter the best you can. Then, when you are in a relaxed state, introduce the idea or decision, allowing your thoughts to focus on your decision points. Don’t forget to keep the deep breathing going!
Once in this state, ask yourself these questions and take note of your responses:
- If money were no object, what would you do? Does this give a different perspective to frame your decision?
- If you had to seek for a solution that is a no-cost or low-cost decision, what would you do? Our society seems to first seek a purchase or money solution, so this may help you think in a different manner.
- Visualize the best and worst case scenarios of your decisions. How could this decision become a life changing choice? Now, if you are simply trying to decide what is for dinner – well that isn’t very important. But what if you are trying to make the choice of whether or not to leave your job? Now, that can have some impact!
- Make a mental or physical note of your emotional state. Through any of these exercises it is important to make mental or physical notes of your emotional state when considering decisions. Writing this down is, of course, the best.
What kinds of feelings, emotions, and biases have you experienced as you’ve made decisions over a period of time? Which direction seems to feel the best both emotionally and logically? Can you spot a trend?
- Acknowledge we have biases. Let’s face it, we are human. Understand that we have biases whether we admit them or not. Do your best to understand that our emotions and our biases will affect our decisions. Keep this in mind and do a double check on your decision process – assuming that you have introduced biases.
We don’t have perfect information!
I truly do not believe we can take the emotions out of our decisions. I suffer sometimes from YOLO, poverty mentality, keeping up with the Joneses, and “I love and hate my job” internal dialog tapes – many times in the same week. How logical is that?!
I am acknowledging that it is important to understand that we are emotional beings, and I know that I have a complex framework that is working subconsciously. Trying to become more conscious, by recognizing your emotions and identifying biases as they creep into decisions, is better than ignoring their impact.
We will never be able to have all the information to make a perfect decision. What is important is to make the best decision you can with the information available now, make a mental note of your emotional state, and make the best decision for now. Once the decision is made, move forward with a positive attitude about a successful outcome, and do your best to adjust once new information has been discovered that can affect your original choice.
How about you? Do you struggle with making financial decisions? Have you found a way to make better quality decisions?