Episode 54
We make financial decisions every day. Some of our decisions are complicated and can have long term ramifications. That’s why it’s so crucial to understand the process you go through in making financial decisions so that you can make the best decision for you and your wallet. On this episode, we discuss the challenges, shortcuts, and solutions to making good financial decisions.

SHOW NOTES

 

Bounded Rationality

Rational - based on or in accordance with reason or logic.

Bounded  - limited, constrained, not knowing everything.

Bounded Rationality is the idea that individual decision making is limited by:

  • Personal information - lack of knowledge - The decision maker might not be aware of all the best information that will help take the optimum decision.

  • Cognitive limitations  - Humans have their own cognitive limitations. They might become biased or judgmental, or may not be able to process all the complex data available.

  • Time constraints - Time is one of the biggest constraints for a human being. He often has to make decisions in haste, due to emergencies, or need of the hour.

Usually, people act in ways to maximize their self-interest. We do things that will increase our happiness. It seems logical that we would make rational decisions in order to accomplish that. Unfortunately, information asymmetry, cognitive biases and other factors conspire to bound our rationality, and people often make choices that lead to outcomes that go against their desires. (I desire to keep it under $200, but now I think there’s no way I can spend less than $200 to get what I want).

 

What are the shortcuts we take to make decisions?

  • Rely on celebrities to tell us about products.

  • Not do something because it’s difficult.

    • We never start investing because of the difficulty of starting.

      • Automatic enrollment.

      • Automatic +1% each year.

  • We get “sold” because we don’t have enough information or enough time to seek out all the available information. 

  • We rely on rules of thumb.

    • Brands.

    • What parents or friends use.

    • Buzz words (organic, non-GMO, no gluten, healthy alternative).

  • So many options that when you’re trying to purchase something you search all the big places first...Google, Amazon, Walmart.

  • Upselling

    • Radio with auxiliary cord.

    • Radio with Bluetooth.

    • Radio that connects to multiple speakers/subwoofer.

    • Touch screen option.

    • Premium brand.

    • Car Play or Android Compatible.

  • Truck Example

    • Adequate, but not over pay.

    • Sense of insecurity.

    • What’s the standard?

    • We can’t go back to the first choice, we now have multiple choices to go through, if I make the wrong choice then I’ll be frustrated and experience pain, so now I’m insecure about the decision.

    • Most people start with a price in mind.

      • Reliable.

      • Provide proper value for the dollars.

    • We no longer have 2-3 choices, we have 10-20 choices, and we have tons of information around each of those choices.

      • Company reviews.

      • Product reviews.

      • Reviews of the reviewing company to see if the review are from actual consumers or they are false?

    • Information overload

      • Having to buy things I’ve never thought of before, and each time I find more information I find new products I have to buy to protect myself and keep my original transaction secure.

  • Store Generic Brands vs. National Branded Companies

    • Adequate, but not over pay.

  • Buying online

    • Amazon

      • Potentially get it faster.

    • Direct from company

      • Trusted source, potentially easier to use warranty.

      • “In Stock”, but then it takes 10 business days.

      • I bought a camera, “in stock” online, then waited two weeks thinking it would arrive any day...after waiting two weeks I called the company and they said it’s not in stock… I asked how long till it was in stock, they didn’t know how long it would take. So I called two weeks later … same things… called two weeks later…. Said the same things and finally up-sold me to something that was in stock that I didn’t originally want.

  • Buying the right house, right neighborhood, good schools.

 

Solution

  • Have a budget and you stick to it. There has to be a limit somewhere.

  • Have margin in your finances so you can deal with unexpected expenses without feeling doubly frustrated by the situation.

  • Be weary of taking every person's opinion as truth. Others people's biases can cause us to eliminate options that might be good solutions.

  • Deal with fear, realize that every decision will come with some uncertainty.

    • Label the fear and label the worst thing that might happen.

      • Do you really need to lose sleep over that.

      • Is your life in danger, is your family in danger, does it completely wreck your finances.

      • Or does it just lead to inconvenience.

    • Buying house in a flood plain for $300,000 vs buying a desk for $300

  • Realize the value of brands.

  • Satisfaction.

    • Sometimes being sold feels good.

 

Good, Cheap, or Fast

Usually get 2 out of the 3. Hard to get all three at once.

1.    Good & Cheap - but have to wait to get it, it won’t happen fast.

2.    Good & Fast - but won’t be cheap.

3.    Cheap & Fast - but it won’t be Good.