Thoughts for the Week | Improving Decision Making
As financial advisors we are in effect responsible for, “the essence of somebody’s ability to live their life, in financial terms, comfortably and completely for the duration.” At some point each of our clients turned to us to help them navigate the constantly changing financial landscape facing them and their families.
Yet behavioral finance teaches us that “human beings don’t always act in their best financial interests,” especially when many of the most critical decisions take place during periods of stress and potential danger (real or perceived). This goes for advisors as well as clients.
So how can we develop the habits, discipline and willpower, to make good financial decisions and avoid the all-too human tendency to shoot ourselves in the foot? A recent Journal of Financial Planning article outlined some research-backed concepts and techniques.
Rely on Habits and Rules - Not Willpower
Psychologist Roy F. Baumeister has found that willpower acts like a muscle – if used repeatedly over time it strengthens. But in the short run it gets tuckered out. When we are stressed, tired or hungry, willpower tends to fade and bad decisions become more likely. Keeping this in mind and taking simple steps to counteract these tendencies can lead to better decision making:
Engage in a reinvigorating activity before making a major decision
o Take a walk, play tennis, do yoga, cook a meal, listen to music, take a nap or sleep on the decision overnight. Abraham Lincoln used to write a letter when he was contemplating a major decision like asking for the resignation of a General or a Cabinet member. He’d put the letter in a drawer and re-read it the next morning. The letter often ended up in the trash can.
Establish simple decision rules as substitutes for willpower
o “Ambiguity makes it easier for the human brain to make deals with itself for why an exception is okay”. To counter, try limited-time experiments. Take investments for example. Short term price fluctuations of long-term assets can lead to destructive decisions. If you find yourself checking your investment account value or the price of your company stock every day, and it causes you angst, see if you can go three days without checking. Then stretch that time, perhaps a week or even a month. Small incremental steps can help prevent those harmful decisions.
Make good habits easier
o Again, turning to investing, having a large sum of money to invest can induce anxiety. That is why we often recommend funding a new investment program by adding relatively small amounts on a regular basis. The smaller, regular investments become habitual, and easier to digest than overcoming the uncertainty of investing huge sums.
Make bad habits harder
o Take spending. If spending decisions are a source of frequent regret or anxiety, put a barrier between you and spending. Keep your credit cards locked in the glove compartment. If you really want to buy something, fine. But the walk to the car to retrieve your card gives you an extra decision zone. Perhaps deleting credit card information on Amazon so you have to manually enter it is the digital equivalent.
Consider all possible outcomes – not just negative ones.
Learned Optimism: How to Change Your Mind and Your Life by Martin Seligman, discusses our tendency to engage in detrimental, “worst-case thinking.” Seligman suggests ways that we can learn to be more flexible in our thinking:
When you are worried about something bad happening, describe the worst, best, and most likely outcomes.
o Forcing yourself to think about the best and most likely cases, and not just the worst-case, may help you broaden your outlook.
If you are inclined to take action, ask yourself what would be the best action for each outcome, and think about the downside risk of each action if that case didn’t come true.
o Often the costs of protecting against the worst-case outcome are so high that you won’t want to proceed. We are happy to help you consider various scenarios if you find yourself having a pessimistic moment. It may even be helpful to email yourself an outline of your fears, the alternatives you consider, and your ultimate decision so that you can refer back and reinforce you discipline in the future.
“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” – William Athur Ward.
We are in the “adjust the sails” business. We have no ability to predict the future, so we help clients focus on things they can control: have a plan that is understandable, build in plenty of redundancy, and be flexible enough to make changes along the way. Improving decision making skills is a huge part of that, for us and for clients. And understanding ways to counter-act common decision traps is part of the improvement process – a process that never really stops.
Enjoy your reading and your weekend,
Mike, Scott & Zack
Private Wealth Advisors
Mike Burbank, Managing Director Wealth Management
Scott Hafeli, CFA
Zack Schiller, CFP
Morgan Stanley Private Wealth Management
555 California Street, 14th Floor | San Francisco, CA 94104
Office: 415 576 3131
Sources:
Behavioral Finance 2.0: Financial Psychology, by Bradley T. Klontz, and Edward J. Horwitz, Journal of Financial Planning, May 2017
The Science of Helping Clients Change, by Kol Birke, CFP, Journal of Financial Planning, May 2017
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