Outcome Bias

When I was shooting with one of my Princesses, it came to light that she was driving without insurance. Since she had never been caught, the Bad Decision had resulted in a positive outcome. Ditto all the people who walk into a casino, put down money they can't afford to lose and win big. Their Bad Decision is reinforced, and they keep going back, often giving up three and four times what they won as they seek to repeat the winning experience.

Then there are the people who fled Hurricane Rita and Houston, experiencing the nightmare of panic only to watch as the hurricane barely grazed the city.  A Good Decision that ended up being a much more uncomfortable experience that the Bad Decision (to stay) would have been.

Can Bad Decisions that turn out well be "smart?" How about Good Decisions that turn out badly; does that make them "dumb?"

This is the same kind of quandary people face when they make investment decisions. Sometime things work out right; sometimes they don't. And we get all bent out of shape, beating ourselves up for making a dumb decision even though it was the right thing to do at the time.

When you make a decision, a whole bunch of things come into play: the possible outcomes, how likely it is that each outcome will happen, and the consequences of each of those outcomes. If you really think the hurricane will hit, and you may be killed, getting in the car and driving away makes perfect sense no matter how arduous a journey it may be.  But what if you're delusional enough to think that you will never be caught driving without insurance, or worse, that you'll never have an accident. Or what if you truly believe – despite all the evidence to the contrary – that you can beat the casino.

This is where "outcome bias" grabs us.  It's an example of how our brains are wired to make bad decisions and why you must be conscious and logical about your choices. If you were one of the fools that stayed in Huston to face the hurricane because you were too stupid to know better, outcome bias will keep you there the next time a hurricane comes barreling down on you. And if you were one of the ones who left, only to watch your Good Decision turn into a dumb one, you'll stay too.

This is exactly the problem with insurance and how some people perceive it. Those that never have to make a claim are ticked at how much money they "wasted" buying something they never needed to use. Others skip buying insurance because, like my Princess, they think they'll never get caught needing it. But if you've every claimed on your insurance, you know just how happy you were to have it in place. And if you didn't have any, you sure wish you had.

The same applies to how some people invest. They take a shot, make a big win, and then spend the rest of their lives trying to duplicate their success with no real focus or strategy for achieving a particular goal. Oy! Then they complain that investing is like gambling. Only for the fools!

Our badly wired brain is one reason you need to understand the rules of sound money management. Like baking, if you don't follow the rules, the soufflé won't come out. While you can always throw an extra teaspoon of salt into your soup or stew, baking demands accuracy. A cup of dry ingredients is different than a cup of liquid. If you whip egg whites that are at room temperature, you'll get more volume. If you bake at a temperature that's too high or too low… well… yuk!

Managing money is a lot like baking: follow the rules and your recipe will turn out. Sure, there will be times when something doesn't work out just the way you planned. Maybe there was a little grease in your bowl and those whites wouldn't whip. Or the market corrects and there's a slide in your net worth. Don't knee-jerk react and throw the bowl at the wall. Just assess where you are and where you want to be and get back on track.

And work on your mindset. Attitude counts as much as following the rules. Whenever I buy insurance I feel like I'm getting twice the value for the money I'm spending: if something goes wrong, thank goodness I had insurance. If nothing goes wrong, that's because I had insurance. Either way I win!

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