If only it was as easy as just saying we were going to stop making bad decisions…
We make decisions every day. While most of them have insignificant consequences, the decisions that have larger ramifications are often the ones that cause us to worry. For many people, investing and their personal finances fall into the category of significant and worrisome decisions. These concerns are well founded. The consequences of potentially biased or irrational investment decisions can be significant.
Recently we had the opportunity to sit in on a fascinating discussion during which Dan Heath covered some of the newest research on overcoming the behavioral biases that lead to bad decision making. Dan and his brother Chip Heath are both academics who excel at turning complex research into actionable recommendations. In their most recent book, Decisive, they write about how to make better choices.
Dan Heath claims that his inspiration for doing the recent research with his brother and writing Decisive came from his desire to take what they describe as the “next step” with respect to behavioral economics.
Behavioral economics is an academic area in which research is done on how human behavior impacts decision making. Psychologist Daniel Kahneman won the Nobel Prize in Economic Sciences in 2002 for his body of work in the area of human behavior. His 2011 book, Thinking Fast and Slow, which summarizes many of his studies, quickly attained best seller status. One of the key conclusions from his work is that we are all prone to errors that come from the fast thinking, emotional, and intuitive output from our brains. We can all benefit from slowing down the decision making process to better utilize the deliberate and logical abilities of our brains.
The Heath brothers were among those inspired by Kahneman’s work. While Kahneman illustrates the many ways our brains influence our bad decisions, the Heaths sought to uncover strategies to overcome the problems resulting from the fast thinking, emotional, and intuitive elements of our brains.
The Heath brothers’ research was focused on what they perceived as the four root causes of bad decision making:
1. Narrow Framing
2. Confirmation Bias
3. Short-term Emotions
Narrow framing causes us to overlook options. Confirmation bias is the risk that we will look for self-serving information that supports our pre-existing beliefs. Short-term emotions cause us to over-prioritize the short-term at the expense of the long-term. Overconfidence refers to the excessive weight we put on our expectations for the future. Collectively, these decision making biases lead to many of our bad decisions.
To overcome these inherent biases, the Heath brothers offer up the WRAP process. Their acronym breaks down as follows:
1. Widen Your Options
2. Reality-Test Your Assumptions
3. Attain Distance Before Deciding
4. Prepare To Be Wrong
They suggest that to widen our choices, we start by eliminating the obvious or quick choices that come immediately to mind. With those options eliminated, we are forced to think creatively and expand the number of potential solutions to be considered.
Reality-testing our assumptions requires that we seek new resources to confirm our beliefs rather than relying on the ones that we know will give us the answers we want. By seeking challenging points of view, we are forced to think about topics more broadly.
Shifting perspective by distancing ourselves from the decisions is one of the most successful strategies for overcoming the strong influence of short-term emotions. Keeping a focus on core priorities and long-term goals when making important decisions can help minimize the impulses to opt for the easy or immediate gratification choices.
The truth is that we really do not know how the future will unfold. Being overconfident in our beliefs about the future is dangerous and can lead to unexpected bad outcomes. As an alternative, planning in advance for bad outcomes can help to minimize the likelihood that they will occur in the first place.
These recommended approaches from the Heaths serve to slow the decision making process and hopefully will lead to more thoughtful decisions.
One of the most interesting concepts discussed by Dan Heath was the use of trip wires. Trip wires in this context are simple tactics that can be employed in advance to avoid future mistakes. The use of trip wires can lengthen the decision making process and provide additional opportunities to ensure that important issues do not get overlooked.
The most memorable example of the use of trip wires discussed was the contract used for stage preparation by the band Van Halen. For years, the media portrayed the band members as divas in part because their contracts were known to include a small clause requiring that M&M candies be supplied in their trailer and that all the brown M&Ms were to be removed. The reality is that the band was not that picky about the color of their candy. Instead, they would insert a couple of sentences about M&Ms into the middle of a rather lengthy legal document that covered all the safety procedures and complex stage construction details. Upon arrival at a concert venue, the band could quickly check the candy dish in their trailer. If there were M&Ms present, and no brown M&Ms, they felt confident that the entire contract had been read carefully. If there were no M&Ms or there was no effort made to eliminate the brown ones, they had the right to insist that every step in the contract be re-verified before they took the stage or they could be paid in full without performing. Their intention was simply to insure their own safety by inserting what the Heath brothers call a trip wire which can help identify a future risk in advance.
Acclaimed investor Warren Buffet earlier this month at the annual meeting of his Berkshire Hathaway shareholders echoed the Heath Brothers’ recommendation for reality testing your assumptions. Buffet suggested that when everything seems to be working well in your portfolio, it is time to listen to somebody who insists you are wrong. Oak Wealth Advisors is fortunate to have clients who ask great questions and remind us on a regular basis that we should be worried about a variety of things that may negatively impact your financial well-being. We welcome the challenges, questions, and reminders. With your assistance, we can produce better results for all of our clients.
At Oak Wealth Advisors, we appreciate the trust that you have placed in us. We recognize that you are counting on us to help you implement successful investment and financial planning strategies. We know that you have faith in our ability to select investments. All of these responsibilities require us to make important decisions on your behalf. We seek research like that being done by Kahneman and the Heaths to understand how we can be more effective in our decision making.
Last year we recommended Kahneman’s book, Thinking Fast and Slow. This summer, we think you might enjoy visiting www.heathbrothers.com. Among the resources available on the website are one page summaries of the key teaching points from the Heaths’ last three books. We hope you will find this information as valuable as we have.
We look forward to helping you make the best possible decisions in 2013 and the years to come.
This update is intended for the use of Oak Wealth Advisors LLC clients. This update should not be viewed as personalized investment or financial planning advice from Oak Wealth Advisors LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult Oak Wealth Advisors LLC. Past performance does not guarantee future results and all investments should be scrutinized before being implemented in a portfolio.