My previous blog topic focused on using a quick decision-making technique called heuristics. The how of decision-making. I will now explain where our heuristic biases come from. The why of decision-making. Once we are aware of the reasons then we are in a better position to reduce their limitations. Thereby helping us to make quick, smart financial decisions that align with our goals.
Why choice affects our decisions
If we have choice that means we have control over our decisions. That is a fantastic thing, as many cultures do not have this luxury. Take arranged marriages in India for example.
The power of choice can be very powerful indeed. Imagine inheriting 2 million dollars. Your outlook on work all of a sudden becomes more positive. The choice to work is now yours since you don’t HAVE to work. Assume you didn’t quit your job the minute your inheritance came in. Both before and after inheriting the money you are working – yet you seem much happier when YOU have the choice whether or not to work. Notice the difference?
Sometimes there can be a discrepancy between the amount of control we actually have and the amount of control we perceive we are stuck with. We have the ability to create choice/control by altering our perceptions of the world. By asserting control in seemingly uncontrollable situations, we can improve our health, wealth and happiness. Those who perceive less control are less likely to escape damaging situations such as toxic work environments, addictions, and abuse. Someone in an abusive relationship will often decide to stay in the relationship, as they don’t see any other choice, even though there is. Their perception is misaligned from reality. Another example is investing in the sharemarket. To someone who has educated themselves it doesn’t seem that scary a place, but to a novice it seems like a jungle that we dare not set foot in. The level of perceived control by the confident investor is very high, yet the novice has no control. The confident investor will most likely make sound financial decisions, whereas the novice will make no decision or costly ones.
This can help to explain why so many people struggle to save for retirement from an early age. Most are aware that this is the right thing to do but many choose not to because when we are 20 it is very hard to imagine being 67. The end is considered so far away that we can’t have any control on an outcome so distant. This couldn’t be further from the truth. The earlier we start saving for retirement the more control we can exert. If we can become financially secure from an early age we can exert control over where we work, prioritising family over work etc.
To conform or not
With more and more choices in this day and age it becomes more difficult to know ourselves, and be ourselves. We like to believe we are alone in a crowd of sheep. We convince ourselves that we are the ones choosing and everyone else is conforming. But we have a natural tendency to want to belong and often change our behaviours to match our surroundings and networks. We seek approval of others. We look to leaders for their opinions before forming our own. Conforming exists everyday and form a large basis of the decisions we make. How will I look to others if I do this?
We like to put others and ourselves in boxes. The cool kids at school adopt a new craze; the ‘geeks’ want to get in on the craze. All of a sudden the cool kids drop the craze as it is now seen as uncool. They don’t want to be in the same box as the geeks. The question then becomes, are we being ourselves or are we conforming to someone else’s expectations? How can something we liked one day all of a sudden be unliked? We act in ways inconsistent with our own desires in order to avoid creating the ‘wrong’ impression.
If we don’t even know our own minds, how do we know what will make us happy?
Who am I?
The unpleasant experience of being caught between two contradictory forces is known as cognitive dissonance and can lead to anxiety, guilt and embarrassment. In order to function successfully we need to resolve the dissonance. For example, one couple try in vain to buy a house in their favourite suburb, but the house ends up being sold to someone else. The couple wander away muttering, “the suburb probably had bad schools anyway”. This is an example of a common strategy used to reduce dissonance.
When we experience a conflict between our beliefs and actions, we can’t rewind the clock and take back what we have already done, so we adjust our beliefs and bring them in line with our actions. It is a coping mechanism that helps us to get on with our lives instead of dwelling on them. If our story about the couple had ended differently with the couple buying the house only to find out the schools were bad, they would have convinced themselves they weren’t so bad after all. This is all an effort to bring their beliefs closer to their decision to buy the house.
By reducing the dissonance gap, that helps us to live with our decisions.
So many choices
Despite it being nice to have all these choices, occasionally it is nice not to have so many. Maybe even someone deciding for you can be nice on the odd occasion. We can even outsource our decisions. If for example, we are not very knowledgeable on investing, we may hire a financial coach or financial adviser. Especially when our knowledge and expertise is lacking. When you don’t know all the information required to make a decision you have 2 options to consider: do you want to take the time to learn and educate yourself to the required level or pay someone else to do it for you? If you value your time highly, then the latter option is most preferred. An ill informed decision can be disastrous on your finances.
In 2000, psychologists Sheena Iyengar and Mark Lepper published a interesting study. On one day, shoppers at an upscale food market saw a display table with 24 varieties of gourmet jam. Those who sampled the spreads received a coupon for $1 off any jam. On another day, shoppers saw a similar table, except that only 6 varieties of the jam were on display. The large display attracted more interest than the small one. But when the time came to purchase, people who saw the large display were one-tenth as likely to buy as people who saw the small display.
Overcoming these heuristic limitations
- Good decisions require us to look inwards at ourselves and our limitations.
- Good decisions are made with our short, medium and long-term goals in mind.
- Good decisions are judged on the process, not the outcome. The outcome may not be what you wanted but sometimes things do happen beyond our control, despite the tricks our minds tell us that we are in control. Keep going with your goal-based decisions. Don’t be disheartened. We all make mistakes and we are not always in control. We are human. Bad outcomes can occur from good decisions.
- Good decisions consider opinions of other people, preferably with different opinions to our own. This is a hard one, as we tend to interact with people most similar to us. Step outside your comfort zone and you will be surprised what you can learn.
- Good decisions look at factors close to our knowledge base, whilst also searching for information on things we don’t know. Seek an expert if you have to.
- Good decisions are sometimes wrong. Analyse why and make any changes required for next time.
- Most decisions do not require this thorough level of reflective analysis, but the big decisions do. As do those smaller decisions that are preventing us from reaching our goals. All other decisions can rely on automatic, habitual decision-making that we have improved through our awareness of our biases.
1/. Determine YOUR goals. By clearly defining your goals you can easily spend less time on decisions that don’t impact your goals and more time on those decisions more closely aligned to your goals.
2/. Make decisions that align with these goals. Discontinue behaviours that don’t align with these goals and continue behaviours that do align with these goals. Now that we are aware of the heuristics we employ, we can identify these behaviours more readily.
3/. When a bad decision is made, question why, learn from it and refer back to steps 1 and 2. Don’t beat yourself up too much. Confidence is a good quality to have for financial success and you don’t want to lose that. It is a fine balancing act though, because too much or not enough confidence can be costly.
Many of these solutions will make you feel uncomfortable. It isn’t easy to assess our limitations, break from the herd, seek advice from others or accept responsibility for poor decisions. However, these are things that need to be implemented if it means making the best decision. We cannot take shortcuts on the things that matter most to us. As hard as it may be, we need to make decisions that are best for us, and anyone else affected by our decision. We must stop caring so much what other people think of our decisions and of us. After all, we are the ones that have to live with the consequences of our decisions.
They probably care much less about your actions than you think.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here
Please comment below on your own decision-making process. Why do you decide the way you do? What works? What doesn’t?