Decision is a critical aspect of personal finance. Our past, present and future are a result of decisions we’ve made and will make. We’ve all been taught to learn from our mistakes. However, if we have an incorrect or incomplete understanding of what has transpired we may incorrectly label a solid decision as a mistake. Conversely, we may incorrectly label a mistake that happened to have a positive outcome as a quality decision. This error in understanding tends to tarnish judgment
1. Decision Quality is not Determined by Outcome
Good decisions sometimes have poor outcomes and poor decisions sometimes have good outcomes. An example: If you liquidate your child’s college fund, go to Vegas for a weekend, and put it all down in one arbitrary hand, is that a good decision? What if you double your money, was it a good decision then? A bad decision is a bad decision, regardless of its result. Chance or luck is not an aspect of decision-making. I love being lucky just as much as the next guy, but I don’t bet on it. The quality of a decision is not a product of its outcome.
2. Decisions are only as Good as the Information and Assumptions they’re Based on
Garbage in, garbage out. This applies to any decision or process, but it is particularly obvious in financial planning. If you base any part of your financial plan on incorrect information or faulty assumptions, the product will be substandard. You can have the best financial planner in the world working for you, but if the data you provide is garbage, the result of the process will be garbage. Ensure that the information used is both correct and complete.
3. Take Context and Purpose into Consideration
Different investments are designed with different goals in mind. Long term investments (i.e. the stock market) will sometimes have poor short-term performance. Short term investments (i.e. Treasury Bills, Savings Accounts, etc.) will often have poor long-term performance (in terms of rate of return). Overlooking such considerations can lead to developing an invalid understanding. Be sure to evaluate results in the proper context.
4. The Human Factor
We have a natural tendency to underestimate the odds of future problems and overestimate the value of current pleasures. Imagine being 70…imagine your lifestyle, where you’ll live, who you’ll live with and how you’ll spend your time. Will your current choices give you the life you want? Is ‘that’ item really worth financing for an exorbitant interest rate? Is it worth increasing your debt? How much will you end up paying in interest when all is said and done? Are you doing it for yourself or to impress others? If the money were invested instead, how much would it be worth in 20 years?
It’s not just about retirement. If you’re young, will your current financial decisions give you the lifestyle you want for you and your family when you have kids or will you be broke, living paycheck to paycheck and financing everything? Something to think about…
Take the above into consideration when evaluating past financial decisions. At the same time, do not skew the facts in order to justify a poor decision. Doing so will reduce the quality of future decisions, it won’t change the past. What’s true is true.