13 Ways to Improve Your Financial Decision-Making

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Editor's Note: This story originally appeared on NewRetirement.

Some sources estimate that we make an astounding 35,000 decisions per day. That works out to roughly 2,000 choices per waking hour. Fortunately, most of those decisions (what to eat for breakfast or what shoes to wear) are made quickly and instinctively.

However, there are many life choices that merit a much more thorough approach. In particular, financial decision-making benefits from deep analysis, careful research, and keeping emotions in check.

Here are tips to help you improve your financial decision-making.

1. Maintain a Holistic Financial Plan

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You are more likely to get where you want to go if you know where “there” is and have a plan for getting there. Stay focused on your long-term goals and you will make better decisions.

Research has found that people who are maintaining a financial plan make better decisions and have better financial outcomes. They save more, invest and use debt appropriately, re-balance, budget, and more.

The NewRetirement Planner is the most powerful and complete tool available online for long-term planning.

2. Slow Down, Give Yourself Time to Be Rational

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Financial decisions should not be made quickly. This is one of the key takeaways from Nobel prize winner Daniel Kahneman’s groundbreaking book, “Thinking, Fast and Slow” and his follow up, “Noise: A Flaw in Human Judgment.”

You may feel like you have to buy or sell a stock (buy a new bike, plane tickets, etc.) today, but you don’t. You don’t need to react to information. You should have a framework for your financial decisions.

Make investment decisions when you know what you are doing and have established the move as part of your overall financial strategy (which would mean you had already slowed down the process).

There are very few decisions that are not improved by sleeping on it. A 24-hour (or longer) waiting period can be a good policy when faced a financial decision.

3. Be Wary of Your Emotions

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Stress. Loss. Fear. Greed. Shame. Envy. Optimism. Confidence. Enrichment.

Those are some of the common emotions that can steer you toward the wrong financial decision. The supposedly good emotions can be as damaging as the negative ones.

Kahneman said, “People are very loss averse and very optimistic.” These emotions work against each other in a particularly damaging way. Because people are optimistic, they don’t realize how bad the odds are.

Loss and optimism are powerful psychological powers driving human behavior:

  • “Loss aversion” refers to the tendency for people to strongly prefer avoiding losses over acquiring gains, often leading to irrational decision-making.
  • On the other hand, “optimism” reflects the tendency to expect positive outcomes and underestimate the likelihood of negative ones, which can sometimes clash with the cautiousness prompted by loss aversion.

Together, these traits illuminate the complex interplay between our desire to avoid negative outcomes and our hopeful outlook on the future.

4. Trust Algorithms

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In a presentation, Kahneman said, “There are very few examples of people outperforming algorithms in making predictive judgments.”

When there’s the possibility of using an algorithm to make a decision, you should use it. While logical thinking can be valuable in decision-making, algorithms offer several advantages, particularly in complex financial scenarios.

Algorithms can analyze vast amounts of data quickly and objectively, identifying patterns and correlations that may not be immediately apparent to humans.

Additionally, algorithms can minimize the influence of emotions and cognitive biases, such as overconfidence or loss aversion, which can lead to suboptimal decisions.

5. Make Financial Decisions as Part of a System of Choices

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The only problem with running a scenario for a financial decision is that you have to realize that the scenarios you are running are not made in isolation. There are myriad other factors, some related and some not, that impact outcomes.

A decision can have a cascading impact. It can trigger a different set of options down the road and change the priority of factors that impact outcomes.

Kahneman said, “See the decision as a member of a class of decisions that you’ll probably have to take.”

6. Think Through Various Possible Outcomes

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When making a decision, you have an idea about what you think and want to happen. But, as the saying goes, “the best laid plans of mice and men often go awry.”

It is useful to consider at least a couple of things that could go wrong with your proposed decision and use that information to help you make the best possible choice.

7. Consider How Regret Influences Decisions

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Kahneman says, “Regret is probably the greatest enemy of good decision-making in personal finance.”

The research suggests that the more potential there is for regret, the greater chance there is that you will make a bad decision.

Regret theory posits that people will anticipate regret and make potentially bad decisions based on bad things that might happen, not necessarily on what is likely to happen.

So, when making a decision, you need to understand that the potential for regret may cause you to make a sub-optimal choice.

8. Make Sure You Ask the Right Questions

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If you aren’t asking the right questions, you have little hope of getting the right answers.

A common problem in financial planning is that many people primarily want to know if they can retire early and how much they need to retire.

These are valid questions, but without determining how long you are going to live and how much you need or want to spend during that time, you can not get to a valid response to the questions for which you really want answers.

9. Get Input From Trusted Advisors — Especially Ones Who Think Differently Than You Do

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Getting input from people you trust can help expand your perspective and limit bad decisions. Just hearing differing opinions can quiet noise that might lead you astray.

Kahneman says that the ideal advisor is “a person who likes you and doesn’t care about your feelings.”

A financial advisor can sometimes fit that description. However, if considering use of an advisor, it is also important to understand:

  • What an advisor stands to gain from one conclusion or another
  • What noise they may be encountering when making their opinion.
  • The relevance of the data used to make the decision — was it based on an anecdote or data?

10. Automate

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Automating savings, investing, and bill paying are all great ideas. It takes the human element of noise out of the equation and enforces consistency.

11. Don’t Over-Index on Short-Term Benefits

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Human beings have an inherent bias toward short-term benefits. However, your financial decisions are important for today, but also your entire future.

It is important to always consider what impact a decision will have on your life right now. Will you have less or more money this month to spend, for example.

However, it is equally important to think about how your financial decisions will impact your future. A dinner out means $100 less to save and invest which alone won’t make or break your financial outlook.

However, if you are doing it weekly, you could be taking a year away from the life you want in retirement.

Here are 7 tips for connecting with your future self in order to make better money decisions today.

12. Put Yourself in Someone Else’s Shoes

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A good way to overcome your own emotions is to visualize how someone else would approach the financial decision you are trying to make.

Think about how other parties involved benefit or lose from your choices and what their interests are. Consider how a friend or colleague might approach the decision.

This is a particularly good tactic if you are being asked to buy a financial product. To understand how the salesperson might benefit from the decision, put yourself in their shoes.

Strive to understand what they get from your choices. Their motivations might not align with your interests.

13. Set up Rules to Guide Decisions

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Not everything can get analyzed with data. When you can not use an algorithm to make a decision, it is useful to have a set of rules to help you know what to do.

For example, let’s take your asset allocation. How your money is invested ought to be based on some sort of logic and the actions you take when your asset allocation falls out of balance should be predetermined. So, if the stock market falls quickly and your funds lose value, you should already know what you are going to do if that happens.

This can be the role of an Investment Policy Statement (IPS). An IPS is meant to define:

  • Investment goals
  • Strategies for achieving those objectives
  • A framework for making intelligent changes to your plan
  • Options for what to do if things don’t go as expected

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