July 13, 2018
I had three ideas for this email. I had them outlined in my head on my way to work this morning. I harmed no pedestrians on the drive to the office despite this trio of ideas distracting me. When I got to work, though, I couldn't decide. I did more research on all three, and that made it worse.
The irony was that one of the topics was on the psychological problem of not making decisions. And my behavior played right into the research - more information and choices was making the problem worse.
Newsweek did a nice summary of decision science, in which they examined decision paralysis. To save you the physical effort of clicking your mouse (or just freezing and doing nothing), I'll excerpt part of it here:
"But decision science has shown that people faced with a plethora of choices are apt to make no decision at all. The clearest example of this comes from studies of financial decisions. In a 2004 study, Sheena Iyengar of Columbia University and colleagues found that the more information people confronted about a 401(k) plan, the more participation fell: from 75 percent to 70 percent as the number of choices rose from two to 11, and to 61 percent when there were 59 options. People felt overwhelmed and opted out. Those who participated chose lower-return options—worse choices."
This is something we see commonly on several levels. When choosing strategies or advisors or when faced with competing arguments, it's not clear what to do, and people stop. And within portfolios, the same effect resides: without conviction one way or the other, the status quo seems safest, even in cases where the status quo may be loaded with risk or underperformance.
Chemistry was never my favorite subject. I couldn't embrace a field where you spent thirty minutes learning a "law," and the next ten hours learning the near-endless exceptions to said law. Regardless, it comes in handy sometimes. Here is the reaction path graph:
Think of financial changes like activation energy in chemistry. You might perceive a better, higher energy state in your future, but to get there, you need to expend energy to get over the hurdle required to start the reaction. It's worse in decision making than chemistry, because you don't know for sure you'll arrive at a better state, making the outcome uncertain.
Our job is to act as a catalyst and push the black line to the dotted red line, to get portfolios out of their frozen state and to ensure decisions are based on a defined set of data, not inertia. While much of this occurs when working with new clients, it's also important that the portfolio not fall into disrepair from lack of decision making over time.
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