5 Tools for Better Decisions – How to separate the quality of a decision from the luck of the result.
Marcus Schafer (00:17)
Welcome to episode 34 of the Decision Dividend, where logic meets life and investing. This is with Pat Collins, CEO of Greenspring Advisors, me, Marcus Schafer, Director of Growth here. You might notice that there is a quick name change. That’s just to better reflect what we talk about on these shows. And it also, I think, leads really nicely into the episode today, which before we talk about, hey, show’s title.
is about decisions. How do you make good decisions? How do you divorce those decisions from outcomes? That’s what today’s show is going to be about, walking through some tools you can use to help you make better decisions. And then we’ll kind of think about some of the science behind why that works and why that’s effective later on for the geeks that want to stay for that portion, including us, obviously.
Trust the Evidence – Why better decisions start with process, data, science, and evidence.
Pat Collins (01:11)
We have a core value at Green Spring that’s called trust the evidence. And it’s this idea that we want to make decisions with data and science and evidence. And rather than using our gut decision, kind of gut brains, gut feels on how we’re going to make decisions, everything from how we invest our clients’ funds to how we run our business internally, how we interview people, how we make decisions about the business.
So I think this is a really near and dear topic for me, because I think good decision making starts with good process and good ways to think about things. And so I’m excited to kind of get into this. We did some research on a lot of the evidence behind it and the idea in the concept of trusty evidence. So yeah, I’m excited to get into this.
When a Decision Needs a Framework – How to decide when a choice deserves structure and when an incremental step is enough.
Marcus Schafer (01:59)
You bring up this ⁓ amazing point. It’s about trusting the evidence, but this stuff is really helpful for us. One of our other core values about mastering our craft and some of this is, it’s a good check. Are we doing these things to help present data and the evidence in a way that helps somebody make a decision? In a lot of these cases, when dealing with money, these could be very high stakes decisions. One of the things that
when the stakes of a decision get higher, there’s this hurdle rate to actually an inertia you have to overcome to make a decision. And the way that you set up your process for doing that decision, what we’ll talk about here in just a moment, it helps you actually just make a choice. ⁓ And I kind of think the, you know, one of the first things you have to decide ⁓ is does this decision even need a lot of deliberation?
You know, is this a decision I should really be structuring my decisions through? Or is this something that is, ⁓ I should just make a choice and get on with it. Or, you know, what’s the next incremental step I can make? We did an episode about cash and essentially one of the things we were talking about is a lot of these, a lot of cash is held in like 0 % yielding solutions. And for the same essentially level of risk or insurance,
you can go and get a much higher yield. To me, that’s a decision that they make that incremental step immediately. You don’t have to really deliberate over that too much. But then if you’re deciding on the next step from there, putting it to market, increasing your risk, doing things like that, then you might need to rely on some of these frameworks that we’re going to talk about here in a moment.
Why Gut Instinct Can Mislead Investors – How the same instincts that helped humans avoid danger can hurt decision-making under uncertainty.
Pat Collins (03:48)
think the research shows that we make hundreds, thousands of decisions every single day. Almost all of them are unconscious type decisions that our brain has kind of created these shortcuts for us to be able to just make decisions quickly. Otherwise we’d be probably paralyzed with trying to get through the day. But I think this has come through like hundreds and thousands of years of evolution over time.
And, you know, a lot of times you’ll hear people say, you know, something like, that’s our reptilian brain. That’s like the brain that just makes very quick decisions without thinking. And I think as we get into this framework, you make a good point is that one, does this even require me to think about this decision? Is it just such an easy decision? There’s not really many trade-offs. I can just do it. But there’s the other side, which is these bigger decisions that we make.
How do we make sure our kind of reptilian brain doesn’t take over and make some of these decisions for us? And I’ll maybe give one example. You know, I think how we evolved as a species was we avoided, you know, kind of danger in the past. So when we saw a lion in front of us, we got out of there, we ran. And that’s that basically the people that didn’t run, those are the ones that didn’t evolve. their gene pool kind of ended a long time ago. The ones that did.
kept on living basically and they progressed and that evolution happened. What’s kind of interesting is that served us well for a long time. I don’t know if it serves us well always with investment decisions. When you think about that same concept of I’m scared, I need to get out of here, which saved us in the past, oftentimes leads us to making bad decisions. You think about, you know, an investment decisions, the more stock markets dropped. It has made me very, very scared.
I am going to sell and get out of this situation. That’s kind of the opposite of what you need to do as a good investor. So I think the frameworks and the tools that we present today hopefully will help people kind of check their gut instincts and put it into some sort of framework that brings in evidence and data to help make a good decision.
The Five Decision Tools – Decision memos, scorecards, base rates, if-then rules, and defaults.
Marcus Schafer (05:59)
Let’s jump in. What are these five tools? I’ll kind of list them really quickly and then we’ll talk about them in a little bit more detail for each. So number one is a decision memo, also kind of called a decision journal. So that’s just thinking about it and then writing about it. Number two is kind of a one page scorecard balancing the trade-offs for these decisions. Number three, base rate card. This is a little geeky.
term, essentially this means what is the average expectation for this decision? Take yourself out of it and think about what maybe would happen for an average person. ⁓ Number four is what we’ll call an if-then execution rule. So these are guardrails around your decision-making process. And then number five is can you make these decisions by default? This is also called precondition.
Decision Memos and Journals (1) – Why writing down your reasoning in advance can help you audit decisions later.
⁓ pre-condition or pre-commitment decisions. ⁓ All right, so Pat, maybe we’ll start with kind of a decision memo. So this is thinking about, hey, you’re going to make, say, an investment decision. How do you write why you’re making this decision? What’s the evidence supporting it? How do you give something that’s kind of this pre-mortem? Here’s my expectation. Here’s why. And the reason you want to do that is because if you write this down in advance,
One, it helps you have confidence in the decision you’re making. But then two, it gives you something to look back on that’s gonna divorce the decision from the outcome. And it kind of helps ground you. And we’ll talk a little bit later around why that’s really important.
Pat Collins (07:40)
You know, we do this, I think about how we work with our clients. And one of the things that we always do is we take notes throughout every meeting and we put them into our internal systems. And then as advisors meet with our clients upcoming, they review past meeting notes to just look at what decisions were made, why do we make them? Do we need to revisit them now? ⁓ If you work with institutional clients, which we do,
They often require meeting minutes that are published for the whole committee to review. And it’s also a very interesting way to go back and basically evaluate decisions that were made. Obviously, you will have the hindsight kind of bias when you look at that. You can say, OK, a year from now, we’re going to go back and look at this. ⁓ And I think that’s a helpful tool. But just documenting your decision making, doesn’t have to be a
you know, a two page memo, it could be something as simple as sending an email to yourself saying, Hey, here’s why I’m making this decision. Or, you know, writing a note somewhere where you can go back and find it, whether that’s an investment decision, a job decision. But I think being able to go audit your decision-making can help maybe save you or improve your decision-making in the future. If you always find that you’re underestimating the risks associated with the decision.
You’ll be able to see that better if you can actually go back, you know, kind of after the fact and go.
Scorecards and Tradeoffs (2) – How a one-page scorecard can make tradeoffs clearer when there is no single right answer.
Marcus Schafer (09:12)
Audit it. We’ll talk about this in a little bit, but this if then this guardrail, that’s really a helpful thing to put into these decisions, these decision demos, because then you can see when you’re breaking a potential guardrail. We’ll talk about that in a moment, but it’s also helpful to delineate, you know, if you’re picking an investment and it’s based upon performance, write that down. All of our disclosures say don’t do that.
⁓ Write that down if you’re making a decision off of a fact sheet from something that a broker did or ⁓ you’re looking at an annuity and somebody provided you this annuity statement. If that is your decision memo, then I think you also have to be concerned about, hey, what’s the conflict of interest from these sources? Is this objective?
advice and trying to control for that and things like this, they just help you do that. ⁓ The next framework is this one page scorecard. And we showed an example of this when we were talking about, should you sell securities from your portfolio or should you take out a loan? There’s like, hey, here’s the different options. Here’s the trade-offs. And there’s no right answer for everyone. If there was, that would be pretty easy. But take your particular
decision you’re thinking about, put it in to those categories and help you visualize, hey, what am I, what trade-offs am I making? And we had some good conversation with clients after that episode and just using that framework. And it helps people have confidence in their decision because they could just see everything on one visual.
Pat Collins (11:00)
Rarely are there no tradeoffs. You you mentioned one in the very beginning of the episode of the idea that someone that has cash sitting in a checking account, earning zero percent that they don’t need in the next, let’s say, month, there’s a very easy kind of no tradeoff type solution or very, probably very low tradeoff solution of moving that into an account that maybe is earning three or four percent. But in most cases, you mentioned making an investment in ⁓ a mutual fund or an annuity or something like that.
Oftentimes you hear the sales pitch as an investor ⁓ and all you hear is the positives and it doesn’t seem like there are trade-offs. so I would, know, this, this process of trying to figure out kind of what are the trade-offs in the alternative decisions that I have in front of me. Sometimes it takes a little bit of work for you to go do it. I mean, one of the easiest things is just go to go to AI or go to Google and you know, let’s use the annuity example and say,
you bad outcomes from annuities or annuity scams or things like that. And you’ll find it really quick. And I think you can do that with most decisions that you’re going to make. It doesn’t mean that you don’t make, you you don’t make that decision or you go and, you know, go in a different direction, but it’s really good to understand the trade-offs before you make the decision.
Base Rates (3, 8) – Why the first question should be what usually happens in similar situations.
Marcus Schafer (12:16)
that leads really nicely into this third tool, ⁓ which I’ll use the complicated term, the base rate decision. And essentially what this means is what’s the average expectation for your decision? What’s the evidence say if you took yourself out of it and you took the time period out of it and you just looked at this broadly? I’ll give an example. We got an email.
the other day and somebody said, you hey, are you going to have access to one of these new IPOs that’s being talked about? Okay, well, let’s think about all the different considerations for this decision. And one of those considerations are, well, first you have to understand, do we think that investing at IPO is good for investors or not? What do need to do?
You need to go back and look at the research for all the other IPOs and evaluate historically has investing in IPOs been a good decision or not. And that helps you have this base rate to understand, here’s our default expectation. Now we really have to be, ⁓ you really have to negotiate us off of that default expectation. You have to have something new, something specific.
And it is really hard to do in the particular industry we’re in, which is trying to be better than market prices in terms of forecasting future returns. That’s tough game, and the evidence says you can’t do it.
Pat Collins (13:54)
We’re so biased with this, with our own personal experiences. mean, to your example, I wouldn’t be surprised if the person asking about that either one read about, you know, some spectacular IPO that happened in the past or participated in one potentially in the past. And that does create this bias of kind of, you know, our previous experiences that we’ve gone through. And so,
So again, I think it’s a really good ⁓ reminder that if we’re making decisions based on our own personal experience, which tend to be very narrow, you it might only be one or two decisions we made that worked out in our favor. And so therefore we think that that’s going to be the outcome for us moving forward. Step back, look at the global set of kind of what’s happened in your example of all the IPOs that have come into play, maybe all the tech IPOs that have come into play, whatever the industry is.
and see what the outcome is there before you go and make a decision. I think it’s a really good step.
Marcus Schafer (14:55)
It’s not to ⁓ diminish the question. The question is a good one, right? And the question is, ⁓ hey, are you guys, are you on top of this? Are you looking at all the opportunities? Are you taking a fresh perspective every single time? ⁓ And the truth is, the answer is much more complicated than that. It’s kind of going into nuance about this. I’m sure if these actually go through, we’ll talk about them in more detail, but you know.
What’s the free float of these? How much do we potentially already have exposure throughout other parts of the portfolio? Right. Cause a lot of public companies are investing in these kind of pre IPO companies, which means you have exposure to it already. What exposure is your portfolio just in the fact that ⁓ if these companies do well, that’s going to benefit all the other companies. What’s the profitability like? There’s all these other ones. And I say that the next tool is.
If-Then Rules and Guardrails (4) – How pre-deciding your trigger and response can reduce improvisation under stress.
these guardrail ⁓ decisions, this if-then execution rule, which is, okay, so first you look at the evidence in this case about, what historically have IPOs done? And then you can start making decisions based upon, okay, well, if these companies turn out to be incredibly profitable, ⁓ maybe that changes how you think about this. Or if you could get access,
kind of at the IPO price, maybe that changes ⁓ your decision making process. But then I think what’s really helpful about this is, okay, well, there’s two sides to every trade. What’s your other trade? And this is very also helpful when people are thinking about getting out of the market because it might be too volatile, right? Okay, if you’re going to be out, what’s your trigger to get back in?
And if you can’t figure out that trigger to get back in, it helps you to, hey, maybe this isn’t the right decision for me because I can’t answer both of these two questions, the if and the then decisions you have to make.
Pat Collins (17:07)
If then framework is really interesting in ⁓ situations where there’s just a very high level of randomness associated with it, and that’s kind of what the stock market is basically, is that there’s a tremendous amount of randomness. So the idea that if ⁓ this is true, then I’m going to do this. ⁓
You just have to be mindful that and I think we’re to talk about this a lot more when we get into some of these, you know, more deeper frameworks to think through. ⁓ But it does create problems if you expect, you know, something to happen over and over again. is a is a real requirement to understand probabilities when you get into some of these things to say, if IPOs have done well in the past, let’s just make that we found we’ve done that research, then.
I’m going to invest in this new IPO and it should do well. Well, it doesn’t really work like that. Then maybe I have a, you know, a slight probability of outperforming the market, but 60 % of the time I do and 40 % of time I don’t. I’m just making these up, but that’s kind of the, that’s where you get to when you have random outcomes is slight, you know, kind of,
outcomes that are slightly better than average kind of thing. And that sometimes it’s tough for people to understand that, you know, we’re making these decisions and we have to expect that they’re bad to say, you know, that the outcomes are bad for many, many times.
Defaults and Precommitment (5, 6, 7) – Why making a decision once can be more effective than re-deciding every month.
Marcus Schafer (18:36)
We’re going to actually come back to that because I think that’s a really interesting line. kind of confuses the… Maybe the mean for the median is a ⁓ statistician’s way of saying that, right? Like, hey, on average, this might turn out well, but that’s driven from a few really great cases. And ⁓ the average chance that you’re going to get that is actually not… It doesn’t look as good. ⁓
framework just to stay on track here. Defaults and pre-commitment. This essentially means, you know, we’re in here, we’re talking, we’ve been talking, I don’t know, for 15 minutes about decisions. Hey, this is tough. Maybe the best thing you can do is make a decision once and then stick with it. And you don’t have to make that decision again and again. So this kind of comes back to a lot of the research we’ve talked about with.
why when we’re working with companies, we auto enroll employees in the 401k plan at a certain rate. And then best practice is to auto-escalate, which means, hey, we’re going to help you get the 100 % of the match day one. And then next year, we’re going to increase your savings by 1 or 2%. And we’re going to do that. And so you hit these target thresholds. When you take decisions away,
kind of happens in the background, you can actually kind of engineer better outcomes for everyone. And we can think about doing that, that type of stuff for, for us as well.
Pat Collins (20:10)
I think this stuff is fascinating. you know, there’s, now lot of evidence. Obviously you have all of these 401k plans and data behind it, but there’s some of the evidence around ⁓ this auto escalation, auto enrollment that you’re talking about. How very few people, when you auto enrollment, roll them into a 401k plan, get out of the plan versus how many people on their own having to make a decision actually go into a plan. It’s staggering the difference.
The other one that I found that kind of supports your, you know, your idea here is the evidence that when you add options to a 401k plan, different menu choices for people to choose from, the more options you choose, the less they make decisions because they feel like there’s so many decisions I need to make. I don’t know what to do. I’m just going to let inertia happen and I’ll still keep it in cash or I won’t even invest at all.
And so I think these are really, really good points to the extent that you can automate a lot of the decision making. It will work well for you. There’s a reason why 401k plans have done so well. And over the years, it’s that people make a decision oftentimes once. And in this case, sometimes the company makes it for them, but they don’t, they, you know, they don’t go back in. don’t, rarely do they go make changes to it.
And it works. You know, 10 years later, they look down and say, well, I have a pretty meaningful retirement savings because I’ve been putting my own money in. It’s been being going into a stock fund or some sort of balanced fund, and it’s growing. And I didn’t make any of those decisions, but it just works because I didn’t have to make decision after decision after decision.
Decision vs. Outcome (1) – Why a bad decision can be rewarded by luck and a good decision can still disappoint.
Marcus Schafer (21:48)
developing kind of routine rules of thumbs, it means it’s not going to be optimal for you. But it’s more optimal than not making a decision. And I think that’s the delineation where a lot of the stuff we talk about is, no, we have to assume you’re already making that first leap. You’re already making good decisions and you’re trying to make great decisions. This is the nuance of those two things. But first, you got to do the little things. ⁓
And that kind of ⁓ brings us into kind of one thing you say a lot, which is what’s the difference between a good decision and a good outcome? And what’s really interesting is when you unpack the research, outcomes drive your perception of decisions, which means if you have a good outcome, it makes you believe you made a good decision.
In fact, if you use some of the frameworks we were talking about at the beginning, you would have said, this is a long shot. I don’t expect this to happen based upon all the evidence. so those frameworks are built around defending against this idea, which is kind of the self-reinforcement loop where you make a decision and the decision’s not that great. And we’ll talk about how to understand that, but the outcome’s great.
And now you’re making new decisions in the future based upon a belief that you made a great decision in the past. ⁓ So just divorcing decisions from outcomes is really helpful and really hard because we’re fighting some of those behavioral ⁓ tendencies you were talking about earlier.
Pat Collins (23:35)
mentioned before about randomness and this really, really gets into probabilities and statistics because, know, I have ⁓ two boys that just got home from college and they were taking finals. And, you know, when you think about taking a test, there’s not a lot of randomness to that, to the answers to their steps. There’s a right and a wrong answer. And if you study, you make good decisions by studying or whatnot, you’re going to get a good outcome. It’s, it’s less, you know, kind of ⁓
impactful this framework for something that is kind of got a known outcome to it. But when you come into things like investing, where there’s so much randomness to it, you can, to your point, you can make really, really bad decisions. You can put all of your money in one stock and we all know that’s a bad decision, but you can get a good outcome. And to your point that the research is fascinating that people will then look backwards.
and basically judge that decision as being a good decision solely because of the outcome. And that’s not really the right way to look at it. So I think if we take that mindset, it gives us a little bit of grace even when we invest to say, you know what, I know it’s not always going to work out perfectly. And I know that from the probabilities. I know the stock market goes down one out of every three years. So if I’m trying to pick stocks or if I’m investing in the stock market, let’s just say,
Yeah, if I consider a bad outcome to be losing money over a one year stretch, OK, I recognize that that’s going to happen. I still think the decision is good to invest in the stock market because two out of every three years and over the long term, stock market is going to be positive. So I do think that it’s just so important to give yourself some grace when you know the probabilities. Understand did I make a good decision? Those five tools that you mentioned in the beginning can help you.
decide, I making a good decision here versus just kind of rolling the dice? I had a friend who ⁓ just turned 50 and ⁓ decided they wanted to go to Atlantic City for a night to go see a show. And we all stopped by and played some blackjack. And ⁓ there’s a lot of parallels to this with gambling. There’s certain things like in blackjack that you do to increase your odds. So if you get dealt
pair of aces, you split them. That’s the best odds that you have. ⁓ So that’s a good decision that you make, but that doesn’t mean you’re going to win those hands. It means that you have a higher probability, but you might lose. And so that’s the same kind of thing when you’re talking about investing is make good decisions, recognize the outcome may not always be in your favor because of the randomness.
But over time, if you do this over and over and over again, you’re putting yourself in a very, very good position to have a good outcome over time.
The Decision 2×2 (1) – A practical way to separate good and bad decisions from good and bad outcomes.
Marcus Schafer (26:33)
One of the ways you could kind of take this and turn it into a practical framework is it’s like a two by two kind of decision, right? Which is for decisions are typically two things you can do. You got to narrow it down to two choices. So I’ll call it good decision, bad decision, or yes, no, depending on you might not know. And then the other ⁓ axis is the outcome. What are the potential outcomes if you make these decisions? And when you put
like investment considerations through those lenses and you’re say, hey, I want to do a single stock with big upside and big downside, or I want to do diversified stocks. And when you run the math, it says like, hey, how much of my life is really going to change if I hit it big on this singular investment? It’s like, well, you got to understand what’s the top and what’s the bottom. What’s the likelihood of those?
And then, you know, it just kind of helps people think through like playing it safe. A lot of times is a good decision. Being simple in most cases is a good decision. If you go back to the, ⁓ should you sell securities or take a loan out for your portfolio? Most of the time, the outcome we come to is the simple decision ends up being way better for most people, but to have confidence to make that simple decision, you have to look at all the complex.
Things to know, hey, every stone was unturned. That’s great. But I’m now more confident that, yeah, being simple is a better outcome.
Pat Collins (28:10)
This has even further reaching kind of implications than just investing too. mean, it’s still maybe in the financial realm, but things like, you know, maybe you’re deciding about a job and you’re in a current job now with very little upside, but get paid really well. And the other alternative is I could go to take a lower paying job that has lots of upside, lots of learning, career progress, things like that. you know,
how do you make that decision? Well, you obviously you want to weigh all of those variables again, using some of the tools that we mentioned before, but you could have a bad outcome. Let’s say you go, let’s say you decide I’m going to stay in the job that I’m at. I think that’s it’s worth it. You could look at that later and maybe you made the right decision for all the reasons that you weighed, but at the end of the day, maybe that company goes through layoffs and you get laid off. You probably are going to look back and say,
gosh, I made a horrible decision to stay in that job. I could have taken that job and been somewhere else. That’s a tough way to kind of look at things because hopefully you made decisions based on all the information that you have. There’s just a lot of randomness to what happened with that company and what happened to you. But again, if you go through that framework over and over again, I think over time you’re going to make better decisions and you’re going to have better outcomes in the aggregate. That’s the key. And I always tell people,
You know, have ⁓ kids, as I mentioned, college age, you know, they talk about, you know, what should I major in? Which classes should I take? I always tell everybody, take a statistics class. It is so important to, you know, when it comes to living your life, because there’s so much randomness in our life ⁓ and understanding patterns and kind of, you know, outcomes and whatnot, understanding probabilities is so valuable, especially with investing.
When Several Things Matter (2) – How weighing multiple criteria can help compare financial and life decisions.
Marcus Schafer (30:02)
Understanding probabilities ⁓ is helpful, especially when you’re also doing what’s ⁓ called this multiple criteria decision analysis, right? So, see your example about ⁓ switching jobs. There’s like, hey, there’s pay criteria, there’s family criteria, there’s all these different things you’re factoring. And one of the…
things that researchers find is helpful in making decisions is list out those criteria. ⁓ Generally with stats, you want to find things that explain the most but are the fewest numbers. So don’t have a whole list of hundred things and try to do this. And then you can wait by probability. You can wait by importance to you. And it helps take subjective considerations and make them numerical.
But I think the most important thing is it helps you just understand all the different criteria, especially if maybe you’re making decisions as a couple or as a family, right? It’s like, hey, let’s just get all the things we care about on paper. And some of this stuff feels weird. It feels weird when you take an MBA class and they make you do it. And then you go through life and you’re like, ⁓ shoot, yeah, it turns out we do have to go back to the basics because I didn’t know.
That was a more important consideration for you than it was for me.
Pat Collins (31:33)
This one’s really interesting. ⁓ I think the first framework we just talked about, which is, you know, decision outcome tends to be like one variable. I’m making one decision and is the outcome good or bad? Basically in life, it rarely is one variable that we’re dealing with. We’re dealing with many. So in this concept that you’re talking about, kind of weighting the variables, the criteria, I just maybe want to give our listeners a couple examples.
of what that could look like. Maybe that give you an idea of how you can use this framework. First would be the whole rent versus buy decision with your where you’re going to live. So that might seem like a one variable thing, but there’s usually multiple things that go into that. So under this kind of framework, you would list out what are the criteria that are important to me? So some of it could be things like, you know, is what’s going to be the better wealth creator? ⁓ Some of this could be job mobility.
You know, like, let’s say I’m starting out my career. Well, if I buy a house where, you know, am I going to be stuck in this one location or can I can I go somewhere else? ⁓ There could be an element of certainty, kind of a peace of mind to some degree of like, where am I going to get more of that in renting or buying? And then the other one might just be prestige, kind of like, you know, maybe we don’t all want to admit it, but, know, I want to be in a certain neighborhood. I want to have a certain group of friends. I want to be in this community.
these could all be criteria and then you could look at those, rank them and say, which is the most important to me? Maybe for some people it’s job mobility. Maybe they’re 25 years old. And the biggest thing for them is they don’t want to get pigeonholed in a certain city. They want to make sure they can move at a moment’s notice or within a few months and go take another job. Other people maybe that have kids say, you know, the community part is most important to me.
So you would wait those and then you would come back and you would say, okay, of both of these options, which how would I rank them? know, is this, you know, a 10 out of 10 or is this a five out of 10 kind of thing? So that’s one way to think about it is what are all the criteria and then rank your decisions that way. The other one that we hear a lot and maybe doesn’t have as many variables, but I think it’s important would be, I’ll stick with real estate is this concept of paying off your mortgage. Should I accelerate my mortgage payments?
Should I get my mortgage paid off or should I invest the money? And so, again, you could go through that framework of where am I gonna get the better wealth creation? What does that look like? But then there could be another element of just peace of mind. And for a lot of people we come across, they would rank that higher than wealth creation. It’s just because of maybe their past or something that’s happened to them, their aversion to debt, and they would say,
I understand that ⁓ wealth creation is important, but I’m gonna rank that lower than peace of mind for myself because of whatever it is, their past, they’re just overall feeling risk aversion. And so it doesn’t always have to be about when you use this framework, optimizing the most amount of money. It’s really about optimizing kind of your utility or the value you get in making these decisions.
And sometimes it doesn’t always mean money. It could be, like I said, it could be peace of mind. It could be community. It could be prestige. These are all things that are still important for a lot of people.
The Outside View (3, 10) – Why personal experience can distort expectations for returns, risk, and future outcomes.
Marcus Schafer (34:56)
It’s so interesting because a lot of times we get the questions we get are, hey, financially, what’s the best decision? And it’s weird to say like, that’s actually pretty mathematical to go to the mortgage prepayment. You know, I just have to ask a few clarifying questions about your situation. And if you’ve done a financial plan, I probably already have all of those. And I can tell you mathematically, here’s the decision. And then somebody’s like,
Yeah, don’t. That’s you answer my question. So it’s a lot of it. It’s just an interesting juxtaposition that in some cases, the things you can quantify, they’re easy. And you want to have conversations over the difficult decisions, you know, Hey, should I retire in a different state because taxes are lower? Okay, we can run your tax return through a different state. can forecast the different projections and say, here’s what it would have looked like to
move there, here’s how much we think you’d save. Here’s some other considerations we know of because we work with people in that state. And then it’s, hey, we also have people that have done this and most of the conversations less about the dollars and more about the sense, the feel. ⁓ And it leads to ⁓ this next thing, which is these are all the complicated terms, reference class forecasting.
outside view base rates. think a lot of this goes back to, ⁓ you were talking about it before we jumped on Pat, but one of the past episodes we did on behavioral finance, because these are saying remove yourself from the equation and think about the average person or the average result. What was that? And this is a key thing because we don’t want to do it.
Pat Collins (36:52)
It’s just really, really hard for people to do this. We always bring our personal circumstances to our decision making. All of our experiences have shaped the way we think about the world, the way we think about investing, planning for the future. So to the extent that you can take your own personal bias out of it, the better probably decision-makings you’re going to get. I’ll use just one example here. I have many examples we can talk about for this, but
You know, we had a client recently, ⁓ a newer client who said, hey, you know, what I’m looking for is, you know, from a a return perspective is to have a 5 % real return, but very, very conservative. And that has kind of been the case over the last 10 years is you’ve been that’s what we’ve experienced, basically. And so for him personally, they basically
had that had had that experience over the last few years and thought that’s a reasonable expectation. They didn’t kind of go back and look at the broader set of what’s actually been the real return of stocks and bonds over time. And the real return of stocks, and when I say real return, return after inflation, has been about 6 % over the last 100 years or so. And so when you look at that, if you want a 5 % real return, especially after you pay fees and expenses and taxes and things like that,
you’re going to have to invest almost all your money in the stock market, which it doesn’t feel very conservative to most people. again, it’s just one of those things where we’re using our own personal experiences to make a decision without looking at the broader set. And so I think that’s an important kind of aspect to say, am I looking at the whole picture here or am I just using my own personal experience to make a decision?
Marcus Schafer (38:40)
especially
see that ⁓ because we all live in America and our stock market has been amazing. That 6 % number, the moment you say, well, what if I was born in any other country and I had the same exact beliefs that I have about America, but now I’m born in Europe or I’m born in South America and I feel the same way about my country.
What would my realistic expectation about future stock market returns be? And they’re all way lower than the US. And the crazy thing is, obviously, we weren’t always the biggest country in the stock market. ⁓ Even if you go back in the last 30 or 40 years, Japan had a time period where it was the top country. You’re like, OK, so one of the things in the frameworks I like to do is I like to
put myself in other people’s shoes. I, okay, well, what if I was a Japanese investor in the eighties and I had the same sentiment? What would that outcome have looked like for me to put all of my money in the Japanese stock market? Because it was the largest stock market in the world and I could get pretty good diversification. ⁓ it wouldn’t have turned out that great. Okay, so maybe I don’t want to do it or, you know, go back to the IPO example.
What are all the different other lenses that these companies are positively affecting my life? Do I really need to add more concentration to this bet that seems like it’s actually powering a lot of other consider? Maybe I don’t need more concentration. Maybe I need more diversification. So this concept of trying to put yourself in other people’s shoes, it turns out these ancient proverbs are actually really, really helpful.
Learning from Wins and Losses (1,9) – Why early success can create overconfidence, and why bad outcomes can sometimes teach useful lessons.
Pat Collins (40:34)
One of the things, it’s going to sound funny, one of the things I think is like one of the worst things that can happen to an investor is that they have some early success picking stocks. I think it creates this false sense of kind of being able to do this effectively. And again, if you take a larger lens, you look at all the research that’s out there. We talk about there’s a professor out at Arizona State, Professor Bessembinder.
that has done this extensive research on just stock returns and has found that a very small portion of stocks have driven a large portion of the returns in the market. ⁓ But I think that that is a…
hard for people to understand if they’ve had some success early. Like, well, I picked Apple in 1997 and I’ve made a ton of money on it. I look back at my own personal experience. The first stock I ever bought was in the late 90s. I was just graduating college basically. And if anybody remembers the late 90s, it was the tech boom. And it went up several hundred percent in the first few months that I bought it.
And then it proceeded to get bankrupt and I lost all of my money. And now, thankfully, it wasn’t a lot of money. You might look at that and say, oh, what a horrible outcome that you had. This is kind of a funnier part to it too. I actually look at this. I made a bad decision and I had a bad outcome. But maybe this is a little bit different than the wrinkle in the framework. I actually look back on that now and say, I made a bad decision and I ended up having a really good outcome. And that is that it taught me
that picking stocks is very, very hard to do. It made me aware of my overconfidence. And I think back on that all the time, that if I had had success ⁓ picking stocks, I don’t know if I would have been where I’m at today, know, the way that we invest money or whatnot, which I think is far superior than trying to predict or figure out what’s going to happen in the future. So ⁓ maybe there’s some elements of this where.
even bad decisions that have bad outcomes can have learning opportunities that can lead to maybe some good outcomes.
Win or Learn – How better decision-making compounds when you review the process, not just the result.
Marcus Schafer (42:49)
Yeah, that’s just mentality, right? Hey, I’m going to learn from this. We say it’s kind of two outcomes. You win or you learn. That should be your framework. It’s not you win or you lose. You win or you learn, and hopefully you’re good enough to do both. You can win and you can learn, but learning leads to winning. It’s actually, I think, more challenging to learn while you’re winning, but maybe that’s it.
discussion for another day. Pat, I don’t know if I could think of anything else to top that wisdom from you at the end.
Pat Collins (43:27)
I appreciate that. ⁓ I think ⁓ this hopefully was helpful for listeners just to give you some more frameworks to think about. Again, we believe that if we can help people make better decisions, it won’t always lead to better outcomes, not every single time, but over time it will lead to really good outcomes if you follow this over and over and over again over a long period of time. So hopefully some of these frameworks are helpful for you. And if you have any questions you want to talk about it, feel free to reach out to us.
Marcus Schafer (43:56)
Absolutely. Yeah, it’s a good reminder for us to, you as we look at this stuff like, hey, are we helping people make decisions? we presenting the information they need to make a confident decision in a clear and straightforward manner? And so that it’s a challenge for us too. And we’ll work on it right now. Thanks, Pat.
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