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Industry Spotlight > Broker Dealers

4 Reasons You Make Bad Decisions

By Danielle Andrus

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Dan Heath, a senior fellow at Duke University’s Center for the Advancement of Social Entrepreneurship and co-author of “Decisive: How to Make Better Choices in Life and Work,” gave attendees at IMCA’s annual conference on Monday four reasons their decisions and their clients’ fail.

Luckily, he also gave four ways to stop making bad decisions.

He illustrated the problem with a quote from Daniel Kahneman, the psychologist and godfather of decision-making research: “A remarkable aspect of your mental life is that you are rarely stumped.” Intuition is a machine that is built to jump to conclusions, Heath said.

There are four ways that machine can break down, he continued.

First is narrow framing. Narrow framing happens when you look at a situation without considering all your options. Heath referred to a Carnegie study of teenagers that found they frame their decisions as “whether or not.” Instead of picking the best of several options, they make simple, yes-or-no decisions.

The Carnegie study found 30% of teens didn’t consider more than one option when they made a decision.

Another study by Paul Nutt, formerly a professor at the Fisher College of Business at Ohio State and an expert in decision making, examined decisions made by 168 organizations. Of those, just 29% considered more than one option.

Heath urged attendees to make “whether or not” an “alarm bell.” When they find they’re trying to decide whether or not to, say, hire an employee or consider a merger with another firm, they should stop and look at their decision more closely.

The second breakdown of intuition is confirmation bias, the tendency people have to look for information that supports their decision without considering information that would oppose it. To prevent that breakdown, advisors need to reality-test their assumptions, Heath said.

When people think they’re looking for truth, what they’re actually looking for is reassurance, Heath said. He referred to Dan Lovallo, a researcher on decision making, who said, “Confirmation bias is probably the single biggest problem in business, because even the most sophisticated people get it wrong. People go out and they’re collecting the data, and they don’t realize they’re cooking the books.”

The third breakdown is short-term emotion, the “visceral stresses” that make people react immediately to an event they should wait to respond to, like a drastic market swing.

In these cases, people want to do what their “gut” tells them to do, which is why advisors have to talk their clients out of leaving the market after a fall instead of waiting it out to take advantage of the upside.

To get around this particular breakdown, the decision maker has to attain some distance from the decision he or she is trying to make. One exercise he suggested is to ask yourself, “What would you tell your best friend to do?”

He illustrated it this way: Say you meet someone you’d like to call, but you’ve only talked to them once. Do you wait until you know that person better or do you go ahead and call anyway?

When Heath asked attendees what they would do, about 60% of the room raised their hand to say they would wait. However, when he asked if they would tell their best friend to call, almost everyone raised their hand.

Heath said short-term emotions — in this example, embarrassment — make it hard to see the whole picture. When considering a decision for someone else, those emotions don’t come into play, and you can see the bigger picture more easily.

“Distance is the fundamental strength of the advisor,” Heath said. Your clients may have started coming to you because of your specialized knowledge, but the “buffer” you provide is why they keep coming back.

The final breakdown is overconfidence, which Heath said does not necessarily mean arrogance, just that people think they know more than they do. The solution here is to prepare to be wrong.

Heath urged attendees to build decision “tripwires” into their plans to remind them to reconsider a particular decision at a certain point. You already have these tripwires in place with stop-limit orders or automatic rebalancing, but you could set up tripwires more customized to your needs, too. For example, Heath said, an advisor could say he won’t consider hiring a new employee until assets under management increase by 10%. Or, say you have a client who wants to start her own consulting firm. You could set a spending limit, say $25,000, at which she would have to reconsider if the business hasn’t gotten off the ground.

Tripwires ensure you’re paying attention at the right moment, Heath said.

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Check out Middle-Class Retirement ‘Under Siege’: IMCA 2014 on ThinkAdvisor.

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