I just started reading a book entitled The Laws of Wealth: Psychology and the Secret to investing, by Dr. Daniel Crosby. In the early chapters he mentions Richard Thaler’s (behavior economist) four qualities of difficult decision making. I started to think about how each of these qualities impacts the decisions we make in life and investing.
The Four Qualities of Difficult Decision Making
- We see the benefits now and the costs later.
- The decision is made infrequently
- The feedback is not immediate
- The language is not clear
Decision Making Impacts our Life, Finances and Investments
Benefits Now, Costs Later
This one I continue to struggle with. Back when I worked my corporate job, my team would routinely go out to the Indian buffet. I love Indian food. Spicy curries are my ultimate comfort food. To add to the problem, I usually would eat breakfast at 5:30 and we wouldn’t get to lunch until 12:30-1:00. By that time I was ravenous.
Two plates later, and I was was fat and happy. The benefit was an immediate fully belly primed to go back to work for another 5 or 7 hours. The costs would arise about an hour or two later. My eyes would start to close and thoughts of napping on my desk would ensue. An hour or two more, my stomach would be smoldering from the heavy spices. Talk about a bad decision. Should have stuck with a salad.
In relation to personal finances, this reminds of car purchases. You get the benefit of riding around in a brand new automobile, your riding high until you get the first car payment.
The one that stands out in my mind is our first home purchase. Home ownership was so exciting. Our first home was a townhouse in Pennsylvania. I think we looked at over 50 houses.
We decided to purchase this house in 2006. It was a over budget and needed some work. The best feature was the location. It was walking distance to large lake and state park. We would kayak and mountain bike all weekend long.
About six months after buying the house, the real estate market tanked. We lived there for 3 years until we were relocated to the south. The house was sold at a major loss. Luckily the corporation covered our losses as part of the relocation package.
We learned a lot about home buying. In hindsight, renting would have been a better option given how overvalued the real estate was. This was a bad decision. Luckily, we were bailed out.
The Feedback is Not Immediate
I already mentioned that we invest our taxable portfolio individual companies. We have been successful on a five year annualized basis of beating the S&P 500 while being less risky and holding plenty of cash. Investing in a company rarely has immediate feedback. Most of the time, I buy a company and it goes nowhere, for months. Sometimes I buy and it continues to go down, sometimes 10 or even 20 percent. I may wait for a year or more to start generating returns.
This decision isn’t for everyone. The uncertainty in the decision making process and the time it takes to obtain clear feedback from purchasing a stock makes it difficult. There are other capital allocation options we could make that would provide instant feedback.
- We could pay off the mortgage to our house providing instant gratification. I will not longer see money automatically pulled from our centralized bank account. Our monthly expenses will be slashed by at least 25%.
- We pondered buying an investment property somewhere within a resort on the coast that our family could use and rent out when we aren’t there. The feedback is immediate, fun in the sun year after year.
- We could buy a local rental property and have it cash flow immediately.
Somehow, we see our wrinkly old selves traveling the world and returning to our ocean front home. Maybe playing a round of golf or a game of bridge at the country club. Most 30 year olds cannot picture what they want in 5 years let alone 30 or 40. Investing in common stocks contains an element of uncertainty. Even the best at it make mistakes.
Language is Not Clear
I am not sure which industry has worse jargon, IT or Finance. In both areas, you may spend years just learning the lingo. Alpha, beta, compound interest and derivatives oh my. Yes, these are my ABCD’s. It can be intimidating. Does this impact how people invest?
In my experience people start making generalizations for things they don’t understand.
- Most active funds don’t perform better then indexes, but some do.
- The stock market is efficient, most of the time.
- The stock market is a casino, but there are some people who do well.
Have these four qualities of difficult decision making burned you? How have you overcome them?