January 16, 2014
By Mark Joseph, CFP®, CPA, PFS, ChFC, CLU
Filed under Investing
My family and I took our first cruise over the Christmas break. We have never taken a cruise before. This is mostly due to the fact that my wife and I saw the Titanic movie. Spoiler alert - it does not end well. And if that wasn’t deterrent enough, earlier this year there was the now notorious sewage gate incident aboard a stranded Carnival cruise ship. If you didn’t read about it, it involved a cruise ship that lost power at sea. When the power went out, so did the toilets. I will leave the rest to your imagination.
The Dreaded Mental Shortcut
By allowing these stories to influence my decision about whether to take a cruise, I realized that I was falling victim to something in my personal life that I always warn my clients about in their financial lives…using a mental shortcut to draw a conclusion. Essentially, mental shortcuts are instant, unexplored conclusions without sufficient factual basis. In essence, jumping to conclusions without all the facts. The Titanic sank therefore I am not going on a cruise. The Carnival ship got stranded so I am not going anywhere near a cruise ship!
In some situations, mental shortcuts are not necessarily bad. We need them to function in our busy and stressful world to dismiss the overwhelming amount of information and choices that constantly bombard us. The important thing is to use them appropriately. You can safely choose toothpaste or spaghetti sauce this way. However, making financial decisions this way can have devastating consequences. Here you need to be thoughtful and deliberate.
How to Avoid Mental Shortcuts
The concept of “case” data versus “base” data is helpful to avoid inappropriate mental shortcuts in your financial life. Base data is the underlying reality and breadth of information available on a particular topic. Case data, on the other hand, is an individual story or event taken from the base data. Using case data can lead to a mental shortcut because it doesn’t consider all the data. Consider the question of whether to take a cruise or not. For the few thousand people who were on board the stranded Carnival ship (case data), I’m sure it was a pretty horrific experience. But what about the estimated other 20,000,000+ people who took cruises in 2013 (base data). Basing your decision on the case data will lead you to a very different conclusion than basing your decision on the base data.
Mental Shortcuts Can Be Hazardous to Your Financial Health
In the financial realm, we have all experienced a friend (we’ll call him Steve) who loves to tell the story (case data) of how he got out of the stock market immediately before a big drop. This is case data reflecting success with one particular event. However, if we follow our natural inclination, we could take a dangerous mental shortcut and decide to follow Steve’s future market timing recommendations. If we took the time and energy to consider the base data, the whole of the data, we would be using a rational basis rather than a mental shortcut to make these life-affecting decisions. To gather base data, we would have to examine all of Steve’s tax returns and brokerage statements. If the market research (base data) that I have seen is any indication, we would most likely find that Steve’s market timing tactics have actually cost him significantly over his lifetime.
As we have said in prior posts, it is equally important to avoid basing your investment decisions on the stories and predictions of the financial press and market prognosticators. The stories presented are generally hand selected to arouse interest and lead you to draw a certain conclusion. If enough stories are pieced together, you can get the false impression that you are hearing all the data.
A key to avoiding mental shortcuts is simply to acknowledge our predisposition to use them. Left unchecked, mental shortcuts can cause us to make rash decisions and abandon a disciplined and well thought out financial strategy. They could also keep you from ever taking your family on a cruise!