Making Decisions As If Your Future Depended On It

    By Dr. William “Marty” Martin
    Choices…choices…choices. Most would agree that it is good to have choices. Some would acknowledge the challenge of having too many choices too often. A choice is a decision. Choices take place under conditions of certainty and uncertainty. In general, making choices under conditions of uncertainty is more difficult than conditions of certainty.
    What are some common choices confronting investors? There are many. Only the most important will be featured here. First, there is the decision of whether to invest money in the bank, in a mutual fund, or directly into a stock market. Second, there is the decision as to how much money to invest. Third, there is the decision of when to put money into an investment. Fourth, there is the decision of when to pull money out of an investment.  The fourth decision, when to pull money out of an investment, is often forgotten or neglected but this is just as important as when to put money into an investment. In short, disciplined investors have an entry and exit strategy for their investments.
    Do I really need an exit strategy? The exit strategy is akin to an emergency evacuation plan. For instance, you may have invested $100,000 in a mutual fund in hopes that it will increase 6% per year but know that if it drops by $10,000 in any given 12 month period,  then that is too much for you to risk and bear. As such, a $10,000 drop signals your exit strategy. We know from behavioral finance that most of us hold onto losers far too long and sell winners far too fast. This is known as the disposition effect. If we have an exit strategy in place as part of our Investment Policy Statement, then we can counter this tendency to sell winners and hold onto losers.
    How can my Investment Policy Statement enable me to make smarter decisions? We are all subject to psychological biases when we make decisions such as the disposition effect. A concrete benefit of an Investment Policy Statement is that it arms us with a planned response to a change in our investment status rather than allowing us to make a decision under the “fight or flight response.” When we make decisions under the “fight or flight response,” our primary aim is to escape danger. To escape danger, we are solely focused on the immediate threat and not the long term consequences. Let’s compare this survival based thinking with longer term, strategic thinking.
    What are the characteristics of longer term, strategic thinking? This type of thinking fully utilizes all parts of our brain not just our lizard brain. Our lizard brain is activated under “fight or flight” and shuts down our higher order thinking processes where logic and reason reside. The three major characteristics of longer term, strategic thinking are as follows:     

(1) greater ability to think through complexity;
(2) enhanced ability to make decisions under uncertainty; and
(3) increased ability to maintain a dual focus-the immediate and the long term.

    How do I acquire and master the art of long term, strategic thinking? First, acknowledge that choices engage your higher thinking processes particularly when it comes to investing. Second, recognize that you must first calm and ground yourself psychologically and emotionally to activate the higher order thought processes in your brain and turn off the lizard brain. Third, adopt a decision making process that you use habitually to make investment decisions. Fourth, cultivate the practice of making scenarios and then selecting the best option given the information that is available. Fifth, engage a “thinking partner” and “sounding board” to collaborate in making smart decisions that are reflective of your values as recommended by Roy Disney, aligned with your life enhancing financial plan, and codified in your Investment Policy Statement.