How to make better decisions
Howdy, friends. Sorry for the long lapse between posts. After returning from a brief summer vacation, the GRS database had imploded. Again. We patched things up this morning and can now resume publishing. Over the next couple of weeks, I plan to share excerpts from three recent money books.
The following is from Buy This, Not That by Sam Dogen with permission from Portfolio, an imprint of the Penguin Publishing Group, a division of Penguin Random House LLC. Copyright © 2022 by Kansei Incorporated.
Please note that I've edited this passage slightly to (a) be more readable on the web and (b) fit within the publisher's word-count limitations. Ready? Let's dive in!
- Rent this house or buy that apartment?
- Invest in a growth stock or an index fund?
- Live in San Francisco or Raleigh?
- Join a start-up or work at an established firm?
These choices all involve an expense of time and capital. Each choice brings risk and reward. The problem is that most of the time we don't have enough information to confidently choose this or that. My approach helps you overcome this information gap.
You do this by thinking in probabilities instead of in binary terms, where it's an all-or-nothing proposition. If you start thinking in probabilities instead of absolutes, you'll develop a stronger analytical mindset to make more winning decisions over time. You'll also be able to make more winning decisions on risks that others never dare take.
One of the biggest decision-making fallacies people fall victim to is thinking they must take action only when there's 100% certainty of success. Here are two examples.
- Only if you are certain someone likes you — because they told their friend, who told you — do you feel confident asking them out. But you might find out years in the future that they liked you as well and were just waiting on you to make the first move.
- Most people put in an offer on a house only once it's listed for sale. But at any given moment, there may be several homeowners in your neighborhood looking to sell, unsure whether they want to go through the hassle of listing their property. By sending out friendly letters of interest, you could very well start a dialogue and end up buying one of the most coveted houses on the block for a good price.
Your goal is to constantly make positive-expected-value decisions in everything you do. A positive-expected-value decision is when you have a greater than 50% probability of your desired outcome coming true.
Some decisions have higher expected values than others, such as accepting a job offer with a guaranteed raise and promotion with a growing company known to cut costs. Some decisions, on the other hand, have murkier expected values due to an overwhelming amount of incomplete information.
It's up to you to do your due diligence to bring your probability of success as close to 100% as possible (while also accepting that very few decisions ever have 100% positive outcomes). There are few sure things in life. So think in probabilities.
The more important the decision you need to make, the higher the edge or positive expected value you should have.
The 70/30 Framework
Now that you understand the importance of making positive-expected-value decisions, let me introduce you to my 70/30 philosophy in decision-making.
The 70/30 framework states that you should seek to make a decision only if you have at least a 70% probability of making an optimal decision. At the same time, have the humility to understand that 30% of the time, you'll make a suboptimal decision and have to live with the consequences.
With more than a two-to-one reward-to-risk ratio, over the long run you'll become very profitable with this decision-making strategy. You'll most certainly have regrets where you'll wish for do-overs. However, you'll also constantly be learning from your mistakes so that you can make even higher positive-expected-value decisions in the future.
But don't get cocky. That's when you'll run the risk of financial and personal ruin. Being overconfident and not properly recognizing risks will be your downfall. The worst mistake you can make is not realizing when a good decision was mostly due to luck, not skill. Proper risk management is paramount.
Expert marketing has also made so many things seem like attractive products, experiences, or investments. But of course, not everything you spend money on or invest in turns out to be as great as expected. Therefore, it's up to you to continually hone the accuracy of your predictions so that they aren't too far from reality. If your predictions are way off, it's imperative that you study why — and make adjustments.
How to Improve Your Forecasting Abilities
The best way to improve your forecasting abilities is to constantly make predictions about uncertain outcomes. For example, if you watch any type of sporting event, before the game starts, make a forecast of who will win, by how how much, and why. Jot your forecasts down to keep yourself honest. Then compare the outcome with your expectations and see what you go wrong and why.
You can practice improving your predictions on practically any type of activity that has an uncertain result. You can make forecasts on:
- which dog will win the dog show
- how long a friend's relationship will last
- how much a house will ultimately sell for and by when
- how long your injury will take to heal
- how many times you'll test for COVID until your results are negative again
Soon you'll start to naturally see everything as a probability matrix. Where others make decisions based solely on gut instinct, you'll go into every decision-making process based on extensive practice, logic, and self-awareness. This is your competitive advantage.
When you're dead wrong, you must review the reasons why and learn from them. Eventually you'll narrow the gap between various outcomes and your expectations to the point where you can confidently say something has at least a 70% probability of succeeding. If you feel your desired outcome has more than double the chance of coming true over the undesired outcome, you're on the right track.
Buy This, Not That is not only a book about achieving financial freedom sooner, it's also a book about making optimal choices for some of life's most important decisions. For each decision, I'll present to you the rationale for why I think you should go a certain way based on what's best for your particular circumstances. My reasoning is based on my own experience, my background in finance, and the perspectives of more than 90 million people who've visited Financial Samurai since 2009.
Not everything will turn out according to plan. We must embrace this truth. However, so long as you continually learn from your mistakes, your decision-making skills will surely improve over time.
Get on the Damn Bus
I came to America with my family from Kuala Lumpur. I was born in Manila while my parents, who worked for the U.S. Foreign Service, were stationed there. We lived in Zambia, the Philippines, Virginia, Japan, Taiwan, and Malaysia, in that order, before coming to northern Virginia when I was fourteen years old. At the time, only about 6% of the population in our town looked like me. It was quite a shock going from being a part of the majority to being a minority.
I had to start over and find new friends while also navigating encounters with bullying and racism. I was also a misfit who lacked the ability to think quickly because my mind constantly bounced between English and Mandarin. My grades and SAT scores were unremarkable too.
I knew my parents weren't rich. They drove beaters and frowned on ordering any drink other than water when we went out to eat. We lived in a modest townhouse in a grungier part of town. I never had a Nintendo. My Air Jordans were hand-me-downs from a friend and two sizes too large. We weren't poor, but we never had more than what we truly needed.
After high school, I attended William & Mary, a public university in Willamsburg, Virginia. We couldn't afford a higher-priced school, and I wasn't smart enough or athletic enough to get scholarships. I did well enough at William & Mary, but that's not how I ended up getting a job at Goldman Sachs after college. The only reason I got a job at Goldman Sachs was because I got on a 6:00 a.m. bus one chilly Saturday morning.
The bus was heading from college to a career fair two hours away in Washington, D.C. Twenty other students signed up to attend, but I was the only person who showed up. After waiting over an hour for the no-shows, the bus driver took me to his company's headquarters, swapped out the bus for a black Lincoln Town car, and personally chauffeured me to the fair. This was the first time I realize that just showing up is more than half the battle.
Seven months, six rounds, and fifty-five interviews later, I finally got the job at One New York Plaza, Goldman's equities headquarters. All because I showed up and stuck with it.
Never in my wildest dreams did I imagine I could leave the corporate grind at age thirty-four to focus on my life's passions. But thanks to Financial Samurai and my investing efforts, I'm now forty-five and financially free to spend time with my wife and two kids, and to work on the things I love.
One saying keeps me going whenever things are hard and I feel like making excuses: “Never fail due to a lack of effort, because effort requires no skill.” I can fail because the competition was too good, or because an unforeseen event knocked me off my feet. But if I fail because I just didn't try hard enough, I know I'll be filled with regret as an old man.
Grit, consistency, and confidence are by far the most important attributes for achieving your goals. Don't think you need to have special skills, innate talent, or rich parents to get ahead. Who you are is good enough already.