How to Make Better Decisions

It's been a busy two weeks in the Rothwards household!

Last Monday, Kim and I had inspections on the home we want to buy. The results weren't good. The inspector concluded that, overall, the house shows evidence of deferred maintenance. Needed repairs have been left undone. Translation: Nearly everything related to the exterior of the home needs work. The roof needs to be replaced, as does the siding. The deck and fence are beginning to fail. And, worst of all, the foundation may be severely damaged.

The country cottage we'd like to buy

When I was younger, this news would have made me distraught. Back then, I was an emotional buyer, not just for small stuff but also for big things like houses. When my ex-wife and I bought our home in 2004, for instance, almost everything about the transaction was emotional. I loved the house (or the idea of the house, anyhow), and that clouded my judgment.

Now, in 2017, I find that I'm much more rational. I understand that there are lots of other houses out there, and that Kim and I could live almost anywhere and be happy. Sure, this particular place meets most of our needs — and it's cute — but neither one of us is overly attached to it. We're making this purchase from a business perspective first and a lifestyle perspective second.

In short, we're doing our best to make a rational decision instead of an emotional decision.

How to Make Better Decisions

Decisive by Chip and Dan Heath
When I first announced that Kim and I were looking for a not-so-big house, Money Boss reader David Hatch suggested I read Decisive by Chip and Dan Heath. This book is all about how to make better decisions in life and work.

“If you study the kinds of decisions people make and the outcomes of those decisions,” the authors write, “you'll find that humanity does not have a particularly impressive track record.” Business decisions are frequently flawed. On a personal level, people fail to save for retirement. We make irrational purchases. We date people we know we oughtn't date.

How can we be make better decisions? It all comes down to process.

“Understanding our shortcomings is not enough to fix them,” the authors write. “It's hard to correct a bias in our mental processes just by being aware of it.” Just because you know which foods are bad for you doesn't mean you'll stop eating them. Being aware that you tend to spend compulsively won't stop you from spending compulsively. To actually make better decisions, you need a plan.

According to the authors, there are four major villains when it comes to making good decisions:

  • Narrow framing, “the tendency to define our choices too narrowly, to see them in binary terms”. Too often, we see our options as either-or, when in fact we have a wide array of choices. We ask ourselves, “Should I do this or that?” instead of “What is my best option here?” So, for instance, you might ask “Should I buy a new car or not?” instead of “What's the best way I could spend money to improve my life?” We ask the wrong questions. Narrow framing makes you miss options.
  • Confirmation bias, which occurs when we reach a quick conclusion then seek only the info that supports this belief while ignoring everything else. “When we want something to be true, we will spotlight the things that support it, and then, when we draw conclusions from those spotlighted scenes, we'll congratulate ourselves on a reasoned decision. Oops.” Confirmation bias leads you to gather self-serving information.
  • Short-term emotion. When making difficult decisions, we get caught up in our feelings. Our minds are so clouded with pros and cons and what-if scenarios that we can't think straight. We lack perspective. We're unable to take the long view. Short-term emotion will often lead you to make poor choices.
  • Overconfidence — unfounded belief in our own abilities and in the direction the future will take. “The problem is that we don't know what we don't know,” the authors write. They cite some findings that boggle my mind. For instance, once study showed that when doctors said they were “completely certain” in a diagnosis, they were wrong 40% of the time. (There are lots of studies like this.) Overconfidence leads us to make poor predictions — and to overestimate our own abilities.

If these are the four villains of decision making, then how do we defeat them? Again, it comes down to having a process, a formalized strategy to help make better decisions. And that's what Decisive is all about.

The Heaths suggest that for each of the four villains of the decision making, there's an effective strategy to defeat it. Taken together, they call their system the “WRAP process”. It works like this:

  • Widen your options to avoid narrow framing.
  • Reality-test your assumptions to avoid confirmation bias.
  • Attain distance before deciding to avoid short-term emotion.
  • Prepare to be wrong to avoid overconfidence.

Let's look at each of these steps in a bit more detail.

Widen Your Options

To make better decisions, you should do what you can to “avoid a narrow frame”. Instead of narrowing your focus quickly, learn to ask yourself these questions:

  • What am I giving up by making this choice?
  • What else could I do with the same time and money?

The authors also suggest a fun thought experiment that they call the Vanishing Options Test. When you're facing a tough choice, pretend that you absolutely cannot choose any of the options you're currently considering. What then would you do?

Another technique to consider is multi-tracking, or exploring multiple options simultaneously. Instead of focusing on one solution at a time, look at several. If that's not possible, then once you find an acceptable solution, look for another. “One rule of thumb is to keep searching for options until you fall in love at least twice,” write the Heaths. So, in my case, I ought not choose a home until I've found at least two that I'd be willing to purchase.

Finally, if you're still struggling to widen your options, look for somebody who has already solved your problem. It's likely that you're not the first person to be faced with the decision you're making. Find someone who's had a similar choice in the past and made what you think is a smart decision. Talk to them. Figure out how they arrived at their solution.

Reality-Test Your Assumptions

When making decisions, people have a tendency to reach a quick conclusion then seek only info that supports the conclusion. As a result, they miss a lot of other options.

One way to avoid falling trap to this sort of confirmation bias is to consider the opposite. The authors suggest we ask ourselves: “What if our least favorite option were actually the best one? What data might convince us of that?” The goal here is to deliberately try to poke holes in your first choice. (When making decisions in groups or organizations, this method is especially effective, and involves listening to dissenters.)

Another technique? Ask somebody smarter than you. “When you're trying to gather good information and reality-test your ideas,” the authors write, “go talk to an expert.” Find somebody with expertise and an outside view to help you evaluate your decision. (As you'll see at the end of this article, that's exactly what Kim and I are doing as we try to decide whether to buy the home with the possible foundation problems.)

One great way to reality-test your assumptions is to take them for a test drive, if you can. Say, for instance, that you think you'd like to make a career change. You're sick of working with people all day and think it might be nice to become a computer programmer. Instead of just making the leap, take some time to find out what it's like to be a computer programmer. Do an informational interview or two. Shadow a programmer for a day. Small experiments like these can help you see whether a decision is right or not.

Attain Distance Before Deciding

I have a history of making emotional decisions — especially when it comes to money. If you look at my early writing from Get Rich Slowly, you'll see that I made all sorts of poor choices based on short-term emotion. A lot of what I was learning a decade ago was how to attain distance before deciding. (Here, for instance, is an article I wrote about how to control impulse spending with the 30-day rule.)

A lot of salespeople capitalize on short-term emotion. When you're at the car dealership, they want you to get jazzed up about the new Prius. They want you to feel like you have to buy it today. They know that when your head is clouded by your feelings, you're likely to buy.

In Decisive, the Heaths advocate the 10/10/10 method invented by Suzy Welch. When you face a difficult decision, consider it from three time frames. Ask yourself:

  • How will I feel about this decision ten minutes from now?
  • How will I feel about this decision ten months from now?
  • How will I feel about this decision ten years from now?

“10/10/10 helps to level the emotional playing field,” the authors write. “That shift can help us keep our short-term emotions in perspective. It's not that we should ignore our short-term emotions…but we should not let them be the boss of us.”

Another way to gain distance is to ask yourself: “What would I tell my best friend to do?”

The Heaths say that perhaps the best way to attain distance before deciding is to honor your core priorities. “By identifying and enshrining your core priorities, you make it easier to resolve present and future dilemmas.” This should sound familiar to most Money Boss readers. The authors are essentially arguing that you should have a personal mission statement, and that you should use this mission statement to avoid making decisions based on short-term emotions.

Prepare to Be Wrong

The final step to making better decisions is to escape the trap of overconfidence. Prepare to be wrong.

A lot of poor decisions come because we try to make guesses about the future. We guess at what events will transpire. We guess at what will make us happy. We guess at what other people will do an say. A lot of times, we're wrong. “Even if we have a pretty good guess about the future,” write the Heaths, “the research on overconfidence suggests that we'll be wrong more often than we think.”

The authors make an interesting assertion. “The future isn't a point,” they say. “It's a range.” Most of the time, we try to predict specific outcomes. A smarter approach is to predict ranges of outcomes. Instead of trying to guess how much money you'll have at retirement, for instance, estimate a ballpark that you're likely to hit. (Instead of estimating you'll have $2 million, estimate that you'll have $1.7 million to $2.3 million.)

To combat overconfidence, the Heaths suggest an exercise called a pre-mortem. Place yourself in the future; imagine what went wrong with your decision. This is something we did every year when planning World Domination Summit. Two weeks before the event, the core team would meet and ask ourselves, “What will go wrong?” We'd spend an hour brainstorming possible disasters — some funny, some serious — and what we'd do if they transpired. This pre-mortem was invaluable and helped us cope with all sorts of mini-catastrophes. (In the event's first year, one of our speakers got food poisoning and couldn't go on stage. Because we'd thought about this during our pre-mortem, we were able to solve the problem on the fly.)

It's also helpful to use “tripwires” to combat overconfidence. A tripwire is a pre-determined action that only triggers when conditions are met. In the world of investing, a “stop-loss order” acts as a tripwire to limit an investor's loss when a stock drops sharply. Self-imposed deadlines can serve a similar function. (“If I haven't found a job in San Francisco in three months, I'll move back to Duluth.”)

The Bottom Line

I read Decisive while Kim and I shopped for a new home. As we shopped, I tried to keep the book's lessons in mind. We did our best to explore a wide range of homes, for instance, instead of narrowing our focus on only one style. When we decided to make an offer on a place, we asked ourselves how we'd feel about it in ten months — and ten years. When the inspection revealed problems, we consulted experts.

Because we're being more methodical than in the past, the homebuying process seems much slower. But I also don't feel like we've done anything dumb. We're being ruled by our heads, not our hearts.

Soon, we'll have a much better idea whether or not we'll purchase the place we've been looking at. After taking some time to read through the inspection report and discuss our budget and goals, Kim and I submitted a repair addendum to the sellers. They accepted it. Here's what we requested:

  • We're willing to take on the expense of replacing the siding, the deck, and the fence. The deck and the fence are relatively low priority, and they're things that I can do myself. (They're things I want to do myself.) It'll be expensive to replace the siding, but it doesn't need to be done right away either.
  • We've asked the sellers to split he cost of replacing the roof. They've agreed to this condition.
  • Finally, we agreed to pay for the structural engineer to issue a statement of findings. The sellers agreed to perform any repairs the report deems necessary. (And either one of us can walk away if these repairs exceed $5000.)

In just a moment — as soon as I hit “publish” on this article — I'll ride my motorcycle over to attend the inspection by the structural engineer. That should reveal whether or not we'll proceed with the purchase.

Over the past month, Kim and I have invested a lot of time (many hours, in my case) and money (nearly $1500!) pursuing this property. Even so, there's a chance it might not work for us. That's okay. If the foundation is faulty, we're willing to walk away — even with the time and money we've sunk into the project. Better to take a small hit than a huge one.

Either way, I'm pleased that we've taken the time (and used a process) to make a better decision!

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Joe
Joe
3 years ago

Decisive sounds like a good book. I will put it on my reading list. Good luck with the house. It’s a tough decision with the potential problems. We’re thinking about moving too and it is creating some conflicts. The missus loves where we are now so she doesn’t want to move. Maybe the book will help us make the decision.
Enjoy the nice weather!

Shara G.
Shara G.
3 years ago

$1500 invested really isn’t that much in the grand scheme of things. And that money is sunk, so don’t even think about it or it can cloud your judgment as well. So what’s your backup plan? When I finally get everything in place to move I intend to sell my house and move somewhere in the interim then take my time finding another. It will be a lot more work but I’m planning to do it that way for a number of reasons: 1) I don’t want to fall in love with a property then fail to sell my current… Read more »

Shara G.
Shara G.
3 years ago
Reply to  Shara G.

OH, another reason I’m thinking of interim housing: people move seasonally and it’s possible to take advantage of that fact if you’re ready for it. Sell in spring and buy in winter.

PawPrint
PawPrint
3 years ago
Reply to  Shara G.

One thing to watch out for with that strategy is that the housing inventory is low in the winter. The prices may be lower, but your choices are limited, in my experience.

Shara G.
Shara G.
3 years ago
Reply to  PawPrint

Yup. Hence wanting time if I find nothing.

PawPrint
PawPrint
3 years ago
Reply to  J.D. Roth

Congratulations on the new place! It looks charming.

JoDi
JoDi
3 years ago

Thanks for the book recommendation. I’ve added it to my reading list.

Congrats on the house! I’m happy to see your follow-up comment about it looking like things are going to work out with the foundation!

Jana
Jana
3 years ago

I’ll add one more. Ask yourself ..”what it the hook?” Sometimes the first good thing about a potential decision overshadows the reasons why we shouldn’t say yes.

The Friendly Russian
The Friendly Russian
3 years ago

First of all, thanks for the book recommendation. Now I have one more book to read.
I used to be really impulsive and emotional with my decisions, instead of using cold math and analysis I was using what felt good. I think there’s a process called maturity that improves our ability to make right and better decisions.

Anne
Anne
3 years ago

Amen, brother.

Ben
Ben
3 years ago

Congrats JD, and thanks for sharing your experience with your home search. These things are never straightforward, and its nice to know others experience twists and turns along the way too.

JB
JB
3 years ago

JD, good to hear the encouraging news from the structural engineer; hopefully everything works out.

Did you and up ever selling the RV? If not, did you ever consider living there if you had to vacate the condo and hadn’t found a new house yet?

Good luck!

The Green Swan
The Green Swan
3 years ago

Those four villains can definitely make decision making challenging and result in regrets later on! When I’ve had major life decisions (buying a house, switching jobs, etc) I’d spend a lot of time thinking and researching. But what helped the most in avoiding the four villains was asking the advice of others. The bigger decision, the more advice I’d seek out. I’ve been in the middle of some career path decisions in recent months and I’d talk to my Dad, boss, trusted mentors / co-workers, and anyone else that would have some valuable insight. I can’t tell you how much… Read more »

Tom Murin
Tom Murin
3 years ago

I read the book early last year and enjoyed it. Another excellent book about decision making is Thinking Fast & Slow. It’s not a breezy read, but very interesting about how we really make decisions and the science behind it.

Durga
Durga
3 years ago

Short-term emotions lead us to wrong decision making, So, we need to avoid emotions ruling our decision power by having self confidence and that to up to a limit and not exceed to be a over confidence. Again this over confidence is too dangerous in making wrong decisions by wrongly considering our capabilities.

Tom Johnston
Tom Johnston
3 years ago

JD,

Thanks for this. We can all strive to improve our thinking, but I wonder how many of us will really be able to implement the wisdom of these insights day to day. As a full-time investor, I am able to deploy some of this stuff already–especially avoiding anchoring bias and the sunk cost fallacy, but I confess I’m still a little skeptical about incorporating a lot of these insights day to day.

Are you really able to do this? Here is an amazing lecture from Charlie Munger on the same topic: https://www.youtube.com/watch?v=pqzcCfUglws

Cheers,

Tom

dave
dave
3 years ago

Thanks for sharing your experience with this house. Also, thanks for sharing your process of keeping your intellect above your emotions. If you are not aware of your emotions, it is so easy to make decisions that will be regrettable once the situation plays out and is evaluated. I like your theory on putting distance between yourself and a major decision. Waiting 30 days to make a purchase seems long enough for your emotions to not be a factor in the decision.

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