“No-regrets” decision-making
Using common-sense economics to prevent regrets in decision-making!
Most people make decisions they regret. We agonize over the impacts of some decisions for years! There are some principles you can follow to prevent this.
The first principle is purely about our mindset when thinking about past decisions.
Judge decisions only by the information you had when you made it!
For example, someone who bought an airline stock right before the COVID crisis may hate themselves. But they didn’t know at the time that a virus would bring down travel right then.
The next principle is to use common-sense economics when making a decision.
Evaluate your decision using common sense economics (and a pinch of probabilities)!
Many times when I discuss a decision with my wife, we randomly bring up reasons for and against a decision and at some point one of us might say lets write down the pros and cons of it!
That’s a good start! It lets you consider the costs and the benefits of a decision. You do need to consider all costs and not just the monetary ones.
For example, taking up a new demanding job could mean less time for your family. What is the value of that time? That’s a cost.
Converting costs to a single scale makes it easier and so it is convenient to say that the lost family time costs you $5,000 a year based on a reasonable comparison.
Benefits are also the same. For example one of the benefits of quitting your job and doing your own thing is flexibility and you need to put a value to it.
Sometimes the outcomes are probabilistic so you may need to know the probability of certain types of outcomes and weigh the costs using them. For example, when playing poker you should weigh the potential payoffs or costs of possible outcomes by the probability they will happen.
Ignore sunk costs! REPEAT. Ignore sunk costs!
While evaluating options a common mistake is to consider sunk costs. Sunk costs are simply costs you have already spent. For example, you’ve read a book for 2 hours and you hate it. But you continue spending another 6 hours on it because you don’t want to stop what you started. That’s a classic bad decision because all you did was waste another 6 hours on top of the 2.
Don’t throw good money (or time) after bad!
The root of most bad business decisions is an inability to ignore sunk costs! Have you ever worked on a project that was going nowhere but kept getting budget year after year? That’s what happens when managers don’t ignore sunk costs.
To correctly evaluate a decision you need to ask yourself a few more questions. A lot of this already happens when you set the decision context. It is worth repeating some of that here.
What type of decision are you making?
First, lets consider a decision that involves choices.
Decisions involving choices are when they are an “either-or” or multiple-option decision. Sometimes we don’t consider “do nothing” or “stick with what you have” as an option. For example, “Should we buy an apartment in the city or a house in the suburbs?” is not complete without a do nothing option (stay in your current rented apartment).
This makes sure that you consider all possible options in a decision. Ignoring an option entirely is the easiest way to make a bad decision!
One other commonly ignored option is: “what else could I be doing?”. This is basically the opportunity cost of any decision.
Do not ignore opportunity costs!
If you setup the options correctly, you will not ignore opportunity costs. “Should I go to college and get a business degree?” is not complete without another option called “Stay in my job”. The money you could have earned in 2 years in your current job instead of getting a degree is the opportunity cost of that degree.
It can get tricky in some cases. “How much dividend should a company pay?” should come after a decision between “Should a company pay dividends or invest back into its products?”
Because the opportunity cost of paying dividends are the returns from investing back into the company.
Imagine making big life decisions such as having a kid. Some costs of having a child are easily seen: their education, health, recreation, toys etc. Some are not: parents have less time for leisure, less freedom to travel on a whim, pressure to earn more etc.
Opportunity costs are harder to see but without considering them you will often pick the wrong option.
Fight inertia!
What is normally termed inertia is simply an inability to ignore sunk costs whilst simultaneously ignoring the opportunity costs of trying something new.
When you keep doing something, you are implicitly choosing to ignore all other ways of doing that! You made a decision but you never checked if it was the right one!
Dealing with quantities
The process is slightly different when you make decisions involving quantities. This will involve a marginal principle because each additional unit of quantity will not usually bring you the same benefit or cost you the same amount as the last one!
Think about a question such as “How many kids should I have?” Economists suggest we break this question down into “Should I have another kid?” and ask it repeatedly.
This is because some of the benefits or costs of having kids do not increase linearly! Education costs will increase linearly but housing costs or your opportunity costs will not. One could argue that after a couple of kids the benefits also may not increase at all!
Economists call this the marginal principle.
So the answer to “How many kids should I have?” or “How many employees should I hire?” should be based on what the status is today and asking the question, “Should I add another kid or another employee?”
Voila! The formula for “no regrets” decision-making
Use all the available information you have to:
- Frame the right decision type (choices or quantity)
- Figure out the options (don’t ignore opportunity costs!)
- Figure out the benefits and the costs: Consider all costs (but don’t forget to ignore the sunk costs!) and benefits, including non-monetary ones by converting to a single scale like money
- Pick the best option and throw away your regrets!
Finally, do not judge your decision-making when new information emerges!
References
- For a great introduction to the economic principles used for decision-making you can listen to the excellent Think Like an Economist podcast
- Most introductory economics principles books work as a good reference
Earlier posts from The Decision School
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