Being a successful investor doesn’t just mean having a sound financial strategy, but it’s also about mental toughness. As long as you are not aware of your biases and shortcomings, you can make emotional investment decisions. As a result of these decisions, investments may be reduced and investment opportunities may also be missed.
In this blog we will discuss 7 tips and tools that you can use to improve your financial decision making.
1. Chunking: Breaking large tasks into smaller tasks
The need to get rich is almost universal, but thinking about how you can reach the end goal can seem like a daunting task. This is where chunking can help you break down the end goal into smaller and more manageable tasks.
For example, suppose you want to invest in stocks. To make your first investment, you don’t need to know everything about the stock market. Instead, you can focus on a very small aspect of the stock market and study it carefully before making your investment. Similarly, you can focus on a specific industry or sector like banking, insurance, metals etc. Before making your first investment.
You can use this principle of chunking to achieve not only your financial but also your professional and personal goals, which can seem overwhelming when you are just starting out. The table below shows how chunking can help you break down the tedious task of earning Rs 1 crore every year into more manageable smaller tasks:
|income source||Current Status (Annual Income)||Status in the next 5 years (annual income)|
|Salary||₹ 30 lakh||₹68 lakh (15% annual increment, 30% on change of job)|
|dividends and income from shares||₹ 1 lakh||₹ 5 lakh|
|rental income||,||₹ 4 lakh (2n/a House; Captured in 4 years)|
|youtube and online courses||,||₹12 lakh|
|real estate broker||,||₹12 Lakh (W.)Weekend)|
|total annual income||₹ 31 lakh||₹1.01 crore|
As you can see, you can break the formidable goal of earning Rs 1 crore into smaller and more achievable goals.
2. Reframing: Consider a Different Perspective
The art of reframing requires you to analyze the current situation from a different angle. This change in perspective can help you assess the situation differently. Doing this exercise can help you work out alternative solutions that might not be easily visible otherwise.
For example, let’s say you own an old elevator-equipped building. If you receive many complaints that the lift is too slow, your first thought may be to replace the old lift or find a way to make the lift faster.
Now, instead of opting for this obvious solution, you can re-frame and look at the problem i.e. unavailability of lift from a different angle. After reframing, you may find that elevator traffic is highest during the lunch break because all tenants have the same lunch time. This perspective could lead to an alternative solution – asking tenants to shorten their lunch breaks during a specific time of day to reduce elevator traffic. Another possible solution might be to make waiting times more pleasant by installing a screen displaying news updates in front of the elevator.
Therefore, financial success is more about finding a better problem to solve rather than overcoming the most common obstacles. From a personal finance point of view, you may hear others say that making money in the stock market is difficult. By reframing you can find out the specific reason why it may be difficult for you to make money in the stock market. Once you have identified this major problem, it will be easy to find the solution so that you can make money from the stock market.
3. Fear Setting: Preparing for the Worst Case
While being optimistic is often the right approach, the fear setting does the opposite. In the fear setting, you have to imagine that you made the wrong decision and force yourself to analyze everything that went wrong from that point onwards. This worst-case analysis can help you identify potential problems and address them before they happen.
One way to implement fear setting in your decision-making process is the 7 Step Fear Setting Framework, developed by Tim Ferriss. This 7 step framework looks like this:
Phase 1: define nightmare scenario
step 2: Identify ways to repair damage
step 3: What are some of the most likely scenarios?
step 4: If you are fired today, how will you regain financial control?
Step 5: What are you avoiding out of fear?
Step 6: What are the financial, emotional and material costs of postponing action?
Step 7: what are you waiting for?
This exercise brings out the natural fear reactions you may experience when things go wrong, but recognizing these fears early is the first step towards conquering them.
4. Mistake Board: Remembering and Learning from Your Mistakes
We all make mistakes, but often we forget our past mistakes. This increases the chances of repeating the same mistake. One way to make sure you remember your mistakes and learn from them is to create a mistake board or wall of shame. This can serve as a reminder of your mistakes so that you don’t end up repeating the same mistakes.
Some examples of mistakes you can include in your mistake board:
- sell a stock too early or too late
- Buying an expensive ULIP or Endowment policy
- Making the wrong investment based on stock tips
- Investing in Futures and Options Without Understanding How They Work
While keeping a framed copy of the fault board can be a great reminder, you can also try a more subtle approach. For example, keeping a scrapbook or diary with a list of investment mistakes you’ve made can also help you achieve the same end result.
5. Reversal: Working backwards from the end result
The concept of working inversely or backwards to arrive at a solution has been used by the famous German mathematician Carl Gustav Jacob Jacobi. While the concept of the inverse may seem counter-intuitive, it can be a powerful tool for solving all kinds of financial problems. While this technique may not be easy to implement, if implemented correctly, it can help you avoid common investing mistakes.
For example to put the reversal into practice consider the question – What should I do to make more money? After applying the inverse, the question will change to – what should I do to destroy my finances? By considering the reverse question, you’ll think the exact opposite way and arrive at an entirely unique set of solutions that can be equally effective in reaching your goals.
The main benefit of using inversion is that it helps you challenge existing beliefs and forces you to think outside the box. In the long term, practicing inversion can make a significant improvement not only to your finances but also to your personal and professional life.
6. Statistical Analysis: Think Like a Statistician
Let’s say you see an anti-smoking campaign poster that shows a 95-year-old man smoking a cigarette. Your first reaction to this image might be that smoking may not be so bad because a heavy smoker has lived a long life. But anti-smoking advertising wants to send a different message – smoking kills. So how can this message be more clearly and easily understood by the target audience?
One way to do this would be to think like a statistician. Suppose you choose 1000 individuals aged 95 years, who are selected from a random sample of 1 million smokers and 1 million non-smokers. Chances are high that the majority of these 1000 individuals will be non-smokers because statistically, non-smokers live longer than non-smokers. If you expand the sample size further to say that there are 1 million individuals aged 95 years, you will still find that most of them are non-smokers.
Thinking like a statistician helps you avoid the tendency to idealize exceptional events. After all, exceptions are not a true representation of reality.
Even in the case of investments, we often focus on exceptional events such as a stock price increases by 300 times within a year or an investment of Rs 1 lakh up to Rs 46 lakh in a few months. These sensationalist events are extrinsic and may lead many individuals to think that high-risk investments such as micro-caps and penny stocks will yield high returns within a short period of time. In fact, for every successful multibagger, there are about 1000 stocks that have failed miserably. This reality becomes apparent only when you think like a statistician.
7. “It happened because…” Method: Analyze the root cause
The “It happened because…” method is a favorite tool of veteran investor Charlie Munger. If one of Munger’s stock investments falls by 10%, he doesn’t worry about the price drop, instead he tries to get to the root cause of why it happened.
The fall in share price can be due to many reasons – geopolitical risk, high valuation, herd mentality of the stock holders etc. Understanding the root cause can help investors make better decisions about whether a particular investment should be kept or sold. Additionally, by avoiding the herd mentality and following a contrarian approach, you may be in a better position to make investment decisions that yield higher returns over the long term.
Each of the 7 mental hacks discussed above are designed to help you think beyond traditional norms and reach innovative solutions.
For example, chunking can help you break down a large formidable task into smaller pieces. Then reframing can help you solve the problem a better. Thinking about worst-case scenarios and their possible solutions can help you identify and plan for various future problems. Similarly, thinking like a statistician helps you cut down on noise, while “why did this happen…” analysis can help you understand the root cause of an investment’s poor or underperformance.
By applying these 7 unique mental hacks, you can improve not only your financial decision making but also your professional and personal decision making.