136. What else will you do?
”But in the real world, your opportunity costs are what you want to make your decisions based on.” — Charlie Munger
A friend (also a client) forwarded me details of a new arbitrage fund being launched by a reputed mutual fund house, asking me if he should invest in it. It did not take me a moment to respond to him with a single word “no”.
Another friend asked me if he should invest in a pension scheme offered by his employer (this pension scheme is facilitated by the government)? There were clear tax benefits but certain constraints on liquidity. This required a bit more information collection and a couple of iterative discussions before I could assess and determine that he should go ahead and invest. I ended up this conversation with “what else will you do anyway?”.
This is the genesis of this blog.
In the first case above, I was able to get back to my friend very quickly but in the second case, I caught myself in unnecessary muddle and took more time and effort before getting back to him.
In the first case, I was able to instinctively assess the opportunity cost of investing in a new investment product whereas in the second case, I entangled myself in assessment of absolute benefits and costs of the investment product.
The bigger point here is that, often, thinking in terms of relative costs and benefits can make decision making easier.
“Everything you do is an opportunity cost. Learn to say No” — Randy Pausch
Do all decisions have opportunity cost, that is, decisions with no alternative options/choices? I can’t think of any. This is because there is always a default alternative of not doing that thing. For example, if the decision is about vacationing in Goa or in Kashmir, there is always a default option of not going anywhere. Just spending time at home.
But, on the face of it, this seems like erroneous thinking. Doing nothing does not seem like a valid alternative option. This feels like a truism. I felt this way too, initially. I felt that I’m being pedantic in my assertion that not doing anything is a default alternative option for every decision.
But I’m not. The fact is that our time on this earth is continuously running out and this makes my point valid. Not doing something means you will not be spending your time on it. The time, you thus saved, becomes the basis for an alternative opportunity, no matter what you do with this time. If we have
infinite time on this earth, then not doing that thing will not be a valid alternative.
Back to practical matters…
Recently Amazon.in came out with their annual (or perhaps half-yearly) sale in India. They advertised it no end. Their advertising was enticing. Lot of mouth-watering deals. I guess, this is somewhat similar to the Thanksgiving sales in the US. Many, naturally, feel compelled to react to such sales and end up buying something — whether there is a need or not. Not buying is an alternative but not taken up by few (or many!).
“Everything has an opportunity cost, and the big things we want in life — like happiness and healthy relationships and wealth — they all have big opportunity costs.” — Mark Manson
Thinking in terms of “opportunity” cost can help address the big questions of life too. A fabulous new job offer can be overwhelmingly attractive. Let us say, you are offered double your current salary along with a much fancier title/designation. In such cases, one may tend to ignore the opportunity cost because the primary opportunity is powerfully attractive. But typically, such great offers require extraordinary sacrifice of personal life. Depending on one’s life stage, this could turn out very costly.
We incur cognitive costs while making decisions. Assessing a decision in isolation typically tends to incur high cognitive costs, whereas it is cheaper to make decisions by assessing opportunity cost. It is easier to see how a new situation is better or worse than the current situation.
One practical way to keep this cognitive load at bay is to make fewer decisions. If every aspect of one’s life is to be at the most productive state, then one will end up making more and more (and more!) decisions. So, it makes sense to limit heavy lifting in decision making to the most impactful aspects of life (like health, relationships and vocation).
“Money is all about opportunity cost. Every time you spend on something, that’s something you can’t spend on something else.” — Dan Ariely
In personal finance, I believe that most people will be best served by focusing on their asset allocation (x% to equity, y% to real estate, z% to fixed income etc) and not as much on individual investment products (stocks of companies, thematic funds etc). This is because in the final picture, generally speaking, significantly more wealth gets created by appropriate asset allocation than by specific products.
Similarly, buying and hoarding fewer things, in general, results in cognitive ease. Automating and/or defaulting to pre-decided options can also ease cognitive load load. Better to fix on a good personal fitness trainer that works for you as opposed to being on a constant lookout for the “best” one. Same goes for tax consultant, investment manager and life partner too.
Better to pick a mutual fund that has been a good performer for a long time as opposed to going for the “best” returning fund (good funds tend to sustain good performance whereas best returning funds tend to revert to mean).
Bottomline
“I think life is a whole series of opportunity costs. You know, you got to marry the best person who is convenient to find who will have you.” — Charlie Munger
Decision making involves cognitive costs. This cost can be reduced significantly by not looking at the decision in isolation. Since there is an opportunity cost involved in every decision, it is best to assess situations relatively. This makes decision making easier. This helps to get around decision paralysis and also the tendency to postpone making (many times, important) decisions too.
But even this will add to cognitive load. A way around it is to make fewer volitional decisions. Automate most everyday decisions by resorting to defaults. Reserve cognitive efforts to decisions that matter most to you and even with them, assess with respect to alternative options.
***************************
Thanks for taking time to read this. In this newsletter, I share my learnings that could help you improve your decisions and make meaningful progress on your goals. I try to share stuff that I have personally experienced or experimented with. If you find this newsletter worthwhile and if you do not mind it, please do consider sharing it with others.
A bit on my background
I help people make better decisions.
I coach people on “Making Better Decisions”, “Financial Intuition” and “Building Great Careers”. I’m open to run sessions on these topics in institutions — this will help me create larger impact.
I’m also an Investment Advisor (RIA) registered with the Securities and the Exchange Board of India (SEBI). As an RIA, I analyze and prepare financial plans to help people achieve their financial goals.
Follow me on LinkedIn by clicking here
