I admire great decision makers and strive to be one of them. Those who can take a situation, understand its full context, come up with multiple possible solutions, and then decide on an optimal approach are coveted in the business world. But great decisions makers need not be limited to the business world. Nope. All of us make multiple decisions every day, including, of course, about our finances (that’s why you’re here right?!). But just how do great decision makers make consistently great decisions? And how can we apply some of that “strategery” to our financial lives? I’m glad you asked :-). Let’s look at 10 essential elements for making consistently good decisions and see how we can use them in our financial lives.
Understand Full Context
Having and understanding the full context behind a potential decision is key when making good decisions. Make sure you know the full context of the matter at hand by gathering relevant details, history, facts, etc. in order to make the best decision possible. Without knowing and understanding the facts behind a situation, you’re already starting on shaky ground. This is why the first post in my series How To Get Control of Your Money starts off with assessing your financial situation. Incorrect or shaky facts lead to incorrect and shaky decisions.
Understand Boundary Conditions
Make sure that you fully understand the boundary conditions which your decisions must satisfy. Without boundary conditions, it’s improbable that you will make a good decision. For example, if you’re deciding whether or not to buy a used car, the boundary conditions for your decision may include a car with total mileage of 40,000 miles or under, a price of no more than $15,000, and a model that is no more than 3 years old. Without knowing the boundary conditions up front, you could end up buying a car that is much too expensive for you to handle (which many people do of course, mainly because they do not have good boundary conditions set for their decisions). Now you know why a budget of some sort is good idea. A budget simply sets boundary conditions upon which you can make your spending decisions.
Use Symptoms to Detect True Problems
Great decision makers understand that most “problems” are simply symptoms of the true problem. Therefore, the goal is not to simply solve the symptom, but to instead dig deeper to identify the actual problem causing the symptom. For example, if you consistently overspend each month, overspending itself may only be a symptom of a deeper problem. The actual problem you need to tackle in order to solve the symptom of overspending could be dealing with low self-esteem that is causing you to seek the admiration of others through buying expensive clothes, instead of only addressing a lack of understanding regarding the basics of handling money. Only addressing the symptom of overspending in this case leaves the door open to the symptom coming back. Addressing both the symptom and the underlying problem though fully addresses the issue at hand. Great decision makers realize this and use symptoms as a way to identify the real problems that need to be solved.
Good decision makers are not satisfied with the first solution that comes to mind. Instead, they look for alternatives so that they can make the best decision possible. This is why it makes sense to comparison shop in order to get the best deal possible. Never be satisfied with the first solution. Always seek alternatives to come to the best decision (deal) possible!
Beware of Biases
Good decision makers are aware of how biases could negatively influence their decisions. Common biases include Status Quo Bias which assumes that the way things are done now is always the best approach (“My family has always had a car payment, so why should I try to buy a car free and clear now?”), Sunk Cost Bias which assumes that past investment of money or time into something automatically justifies continuing future investments into that thing (“I just paid $2,000 to have this engine fixed last month. There’s no way I’m going to buy a new car now! I’ll go ahead and spend another $750 to fix the water heater that just broke down too.”), and my favorite, Ego Bias, which says that you’re always right, and everyone else is always wrong (“Yes I am. This is why I’m going ahead and fixing that water heater.”). The key to avoiding any kind of bias is to aim to think objectively about the situation and challenge your assumptions. Why is the old way necessarily the best way? Why does previous investment automatically justify future investment? Am I really making the best decision with my money here?
A premise is simply a hypothesis based upon a set of facts from which a conclusion is drawn. I think of a premise as being the next layer of reasoning which I place on top of the foundation of facts that I already have (i.e., first understanding the full context). Take the following statement as an example of a bad premise leading to a bad conclusion: “Many people are making money online through blogging (Fact) because making money blogging does not take a lot of work (Premise). Therefore, the best way for me to make money quickly is to start blogging! (Conclusion)” Many people are indeed making money blogging, but the interpretation of why is incorrect, leading to an incorrect conclusion (believe me!). Obviously, the key to overcoming a faulty premise is to check your interpretation of facts to make sure your interpretation is indeed sound.
Otherwise known as logical fallacies, faulty reasoning is simply bad logic applied during the course of decision making. Even if the premise is correct, the reasoning used to reach a final conclusion can still be incorrect. For example, a Realtor could say the following: “Interest rates will be rising soon (Fact) so now is a great time to buy a home (Premise). If you do not buy a home within the next month you will probably regret it (Conclusion).” Such a statement is a logical fallacy called a False Dilemma where only two alternatives are presented (Buy now or regret it) while there are actually more than two alternatives to consider (such as buying in six months instead). Salespeople in particular love to create false dilemmas. Being cognizant of this tactic and other logical fallacies can help you spot them in your own logic and that of others trying to influence your financial decisions (because YOLO!).
Have you ever agreed with a decision because you thought everyone else agreed with the decision? And everyone else agreed with the decision because they also thought that everyone else agreed too? This is Groupthink – When a group of people value harmony and consensus above reaching the best possible decision through any means necessary, including reasonable dissent. Couples – Watch out for this one in particular. Husbands: Don’t agree to make that purchase just because you assume Happy Wife, Happy Life. Wives: Don’t agree on buying that vacation home just because you assume that’s what your husband really wants. Poke holes in each others’ proposals, logic, and interpretations until you have enough alternatives to make the best decision, not the one that you assume the other wants. It is a good thing when couples disagree knowing that they have each others’ best interests in mind in the process of disagreeing.
Add Analysis Such As Cost/Benefit & Risk/Reward
In addition to all of the above, you’ll want to add some analysis to your financial decisions. Cost/Benefit analysis simply weighs potential costs against potential benefits so that you can see if a possible financial decision is “worth it.” Simple Example: Buying a new Laptop for $500 is well worth it if I expect to be able to increase my online revenue by $100 a month because of it. In that case, it would only take me five months to break-even. The longer I keep my laptop after that break-even point, the better my Return on Investment (ROI). Risk/Reward analysis is similar in that you’re weighing the risk of taking (or not taking) a particular course of action against the reward of taking (or not taking) a certain action. For example, foregoing paying for health insurance for a healthy 20-year old is a lower risk than for a 45-year old pre-diabetic. The reward for both would be having peace of mind about possible future healthcare costs, but for the cash strapped 20 year-old, having a few extra bucks in their pockets for a few more months may be worth the risk (not that I recommend this, simply an example). Both types of analysis will help you in mapping out the viability of all alternatives.
Think Through Consequences
Last, but not least, good decision makers think through all possible consequences when considering possible solutions to a decision. You already know that I’m a fan of asking “What if…?” as this is a great way to get your mind in “consequence mode.” Exploring consequences is a great way to better judge whether you will be okay with taking one course of action (and it’s accompanying possible consequences) over another.
Incorporating the above elements of great decision making in your financial life will yield a harvest of great financial decisions. Here’s to growing your Net Worth through better decision making.