Improving your decision-making process can lead to a more financially secure life

By Bob Peters || December 18, 2023

Decisions, Probabilities and Tools

Life can be described in many ways but for purposes consistent with helping young people achieve a financially secure and less stressful life I will choose to describe Life as a series of decisions. Better decision-making improves your life.  Everyone makes decisions every day covering the range of consequential and inconsequential. In the blog post, Mental Immunity and Joy are Good For Achieving Financial Security I referenced Nobel Prize winner Daniel Kahneman’s book, Thinking Fast and Slow who explains the interplay between our intuitive, automatic thinking (fast) and our deliberate, thoughtful reasoning (slow), revealing the biases and cognitive shortcuts that shape our decisions. Any decision, whether financial or non-financial, is made to address a desired outcome. Your ability to successfully achieve life goals is a function of making decisions that lead to outcomes getting you closer to the goal.  Increasing the number of desired outcomes in life is a worthy pursuit which will improve the probability of financial security and lower stress.  The remainder of this blog post will focus on how incorporating probability into decision-making and being on the lookout for “tools” can be helpful to improve the number of desired outcomes. 

Decision Making:  Imperfect information and luck 

There are two important considerations when making a decision; imperfect information and luck.  You often do not have all information when making a decision and the ultimate outcome is influenced, to a degree, by luck.  When we get an outcome, we do not fully understand how much of the outcome was attributable to luck.  This makes us overestimate our competency in decision-making.  For instance, let’s make up a hypothetical. 

YOU CAN BE RIGHT FOR THE WRONG REASON 

There are two companies that each have profitable operations, ABC Company and XYZ Company. These businesses operate in an industry where there are no other competitors…also called a duopoly.  Both companies share 50% of the market and have similar profit margins.  You make a decision to invest in ABC Company on a Friday.  You relied on all publicly available information and decided that ABC had good prospects.

The next day, you read a press release that the CEO of XYZ company had died of a heart attack and that the main plant for XYZ was significantly damaged in a natural disaster.  Over the following weeks and months, the price of ABC shares climbed as the price of XYZ shares slumped.   As you read this it seems obvious that luck played a large part in the “success” you enjoyed investing in ABC, but the human brain does not process the analysis in such a straightforward manner.  You will likely give yourself a pat on the back for being a shrewd investor which will contribute to your overconfidence as someone who can pick individual stocks.  Note to self: You cannot measure the quality of the decision by the outcome.  You can be right for the wrong reason. 

The importance of using probability to improve the quality of decisions? 

When approaching a decision, it makes sense to keep in mind how to maximize the probability that we get closer to the goal we have established. Decision quality will describe the accuracy with which we select options to achieve our goal.   

Decisions require an understanding of two things:  Knowing what you know to be true (facts) and knowing what you do not know that could impact the outcome of the decision.  Understanding what you do not know that could impact the outcome is just as important as knowing what you do know.  Bad decisions can come from being overconfident in facts that are not true and by underestimating the impact of uncertainty. 

Decisions can be improved by seeking out other people’s opinions who might have knowledge and information that you do not possess. They can fill in the knowledge gap to better equip you with more complete and/or accurate facts.  The other benefit of seeking out the opinion of others is that their life experiences will give you a broader sense of how they see the unknown.  It is not about asking just anyone for their opinion, rather selecting people who you believe have experience, judgement and a life experience that would make their input of value as you make decisions.  The point here is that seeking out the opinion of others can lead to better quality decisions even though it is no guaranty that a desired outcome will be realized. 

Most investors who purchase individual stocks suffer from overconfidence:  When the tide goes out, we see who is swimming naked.

The saying, “When the tide goes out, we see who is swimming naked” I believe is attributable to Warren Buffett but has been referenced thousands of times. The essence of this phrase is that when times are good, disciplined investors, speculators, and wild risk takers alike all may “look good” but when tough times come, speculators and wild risk takers will shed many a tear.  There are many folks who made investment decisions that were attributable to luck (i.e., ABC company) and believed in their investment prowess only to find that they fail spectacularly when luck does not go their way.  Recall, you can be right for the wrong reason. 

A 40-year tailwind contributes to overconfidence 

In my post, “Part 3: Risk Free Rates and the Price of Investments, The Yield Curve, The Fed, Inflation and Matching Investments”, I tried to describe a basic and important investment concept to understand.  That concept is: As the US Government’s borrowing costs increase, the value of all other investments decreases. Conversely, as US Government borrowing costs decrease (as per the chart below), the value of all other investments increases.  So, as we look back 40 years, except for the last several years, we see a general decline in the US Governments’ cost of borrowing as depicted by the decline in the 10-year treasury rates which would act as a “tailwind” to asset prices like stocks, real estate. 

10 Year US Treasury Rates credit:  <a href=’https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart’>10 Year Treasury Rate – 54 Year Historical Chart</a>

Another way to look at this 40-year decline in the US Government’s borrowing cost is that it was a period where many less talented investors enjoyed attractive investment returns attributable to the long-term decline in interest rates, not because of their investment acumen. From 1981 when the 10-year treasury rate peaked at 15.84% we have had a near 40-year slide to the bottom at .62% in July 2020. Wow, what a tailwind it was.  Earlier this year, the 10-year treasury peaked at 5%; the tailwind has shifted to a headwind. 

How to think about Probabilities…a job interview 

I learned to appreciate how useful statistics is to everyday life, and specifically, all aspects of decision-making. I am far from a statistician or actuary but incorporating probability analysis into decision-making improves outcomes.  For example, the probability that you will be offered a job after an interview is improved if you are well groomed (teeth brushed, hair combed, clothes ironed) and have prepared for the interview by understanding the business, how your experience has prepared you to take the job, examples you can share about your work ethic and how you have handled difficult situations.  If the objective is getting a job offer, you would be well served to understand how best to be prepared and present yourself. 

…an investment decision 

There is considerable peer reviewed research that indicates that human behavior causes many folks to sell their equity holdings when the market declines because they experience fear. The research also shows that had they held onto their investments (and added more if possible) the long run returns would be improved. While there are no certainties when forecasting the future, a probability analysis incorporating historical market swings would better prepare you to overcome the fear of a severe short-term investment loss.  

Look for and embrace every tool you can 

One of my closest friends growing up had severe dyslexia and struggled to read. Fortunately, he embraced the need to seek out a tool that would help him pursue his education.  In his case a specific university that accommodated his learning disability by allowing him to have all assignments and lectures available on audio tape was his “tool.” (Yes, audio tape was a thing in the seventies before the digital world we live in today) 

If you want to maintain a budget, you might want to learn basic Excel. If you struggle with organization and time management, there are calendar applications you can use on your phone to help plan your day, week, or month.  If you want to change a tire on your car it serves you well to have a proper tire iron and jack.  Although there are negative connotations associated with referencing a person as a “tool” people can be amongst the most valuable tools you can imagine.  People who care about your best interest (mentors, teachers, family, friends, coaches) can help give you encouragement, direction, and honest feedback just like doctors, plumbers, electricians can improve health, fix a faucet, and install an electrical panel. 

One of the most important takeaways from my career was the importance of feeling confident to admit you do not know an answer. You will be well served not to confuse the absence of knowledge with low self-esteem.  I would suggest that admitting that you do not know and seeking out tools (physical, digital, or relational) to help you learn and achieve a desired outcome is a sign that you are humble and possess the right combination of self-confidence and self-awareness.  Seeking out people in your life who embrace this mindset will serve you well.  Your decision-making process will improve as will the probability that you will achieve your desired outcomes.  Better decision-making improves your life.