The downside of living in the information age is that you can exhaustively research every decision before you make it.
You heard me right: the downside of the information age is having excess information to help make decisions.
It might seem like more information leads to better decisions, but the vast majority of information is irrelevant. More information means more to think about, and more time spent deliberating.
Some decisions are very important and should be handled with intense care. Other decisions might have important implications, but taking decisive action is more important than getting it exactly right.
The important thing is to have a mental framework for quickly identifying what kind of decision you are facing. This will let you know how you should handle your decision making process.
The Outcome Report Card Method
One of my favorite ways to look at decisions is with a tool I call the outcome report card method.
The idea is to assign a grade to possible outcomes using the grading system they use in American schools. So a good decision that results in a good outcome will get graded as an A or A+. A bad decision might get a D- or even an F.
I came up with this framework when I started to write about personal finance and saw people wringing their hands over decisions that should have been handled quickly and decisively. Things like “should I invest in a traditional IRA or the Roth?” Or “should I invest or pay off low-interest debt?”
By looking at how broad the spread of possible outcomes is for a decision, you can determine how much time you should spend making it.
So here’s the rule: If the range of outcomes is narrow, go with your gut or flip a coin, but act decisively. If the range of outcomes is broad, take as much time as you need to get it right.
Let’s look at how this works in practice:
Decisions With a Narrow Range of Outcomes
Should I invest in a traditional IRA or a Roth?
Here’s the “correct” answer: Roth IRA’s save you money on taxes in the future, and traditional IRA’s help you save on taxes now. Go with the Roth if you think you’ll make more in retirement than you do now, go with the traditional if you think you’ll make less in retirement than you do now.
You might have noticed the problem that most people struggle with: How do I know whether or not I’ll make more money in retirement?
The truth is, you can’t know for sure. You can make reasonable guesses based on your plans and what you believe market conditions will be going forward, but even reasonable guesses can easily be wrong.
Most people probably won’t be able to definitively say which one of these options will be better for them in the long run. But do you know what you can say with confidence? Picking either option will be better than sitting on your hands and doing nothing.
I call this an A/A+ decision; whatever you pick, you win, even if you could have potentially won bigger with the other option.
Should I Invest or Pay Off Low Interest Debt?
First of all, I’m taking it for granted that you are already making the minimum payments on your debt and investing in your 401k up to your employer’s match. If you aren’t, then doing both of those is your first priorities. If you can’t afford to do that, you need to stop reading this and figure out how to slash your spending and start earning more income ASAP.
And of course, if you have high interest debt, it’s probably a good idea to pay that off before you start investing.
With lower interest debt however, it’s not so clear what the right option is. On the one hand, you bring yourself more financial security by paying off debt, but on the other you might wind up with a higher net worth in the long run if you focus on investing.
Again, the important thing is that this is an A/A+ decision. You win either way. If the security of paying off debt sounds better to you, pay off your debt. If maximizing your net worth sounds good, consider investing. If they both sound good, flip a coin.
Whatever you choose, put your plan into action today.
Debt Snowball vs. Debt Avalanche
When it comes to paying off your debt, there’s two main options. You can either pay off the debt with the lowest balance first (debt snowball) or you can pay down the debt with the highest interest first (debt avalanche).
The debt snowball is recommended by Dave Ramsey. The idea is that getting a quick win will motivate you to continue to pay down your debt until it’s all gone.
The debt avalanches is the more traditional approach. It will save you the most money on interest.
So how do you decide? Well, do you need a psychological boost or do you want to save the most money possible? If you didn’t think of answer to that question in five seconds, flip a coin.
Just get started paying extra towards your debt. Heck, you could pick one of your debts at random to start paying down early and it would be better than doing nothing.
Traditional IRA vs. Roth IRA
Here’s an overly simplified comparison between these two accounts in just a few sentences:
- They’re both retirement accounts with annual contribution limits that save you money on taxes compared to a regular brokerage account
- The traditional IRA saves you money on taxes this year
- The Roth saves you money the year you take it out
So which is better?
Well, are you making more money now than you will be in retirement? If so, maybe you should consider the traditional. If not, the Roth might be the right move.
If you aren’t sure, pick one and get started.
The literal worst thing that can happen is that you realize that the other one would have been slightly better, so you stop contributing to the one and start contributing to the other.
Total Stock Market vs. S&P 500 Index Fund
If you’ve been reading this blog for a while, you know I’m a big fan of index funds. They’re a low cost, set it and forget it way of investing.
Two great flavors of stock market index fund are the total stock market index fund and the S&P 500.
What’s the difference? The total stock market fund seeks to own nearly every publicly traded company. The S&P 500 just focuses on 500 of the biggest companies.
So which is better? They’re mostly the same. About 80% of the returns of the total stock market are determined by what happens to the 500 largest companies. There have been stretches of time where each one has done slightly better than the other, but there’s no way of predicting which will be better in the future.
And whichever one is better will only be slightly better. Because they’re mostly the same.
I guess I prefer the total stock market, but I actually have more money in an S&P 500 fund because my company’s 401k doesn’t offer a total stock market index fund.
Decisions With a Broad Range of Outcomes
Who You Are Going to Marry
If you get this decision right and choose a suitable marriage partner, it is going to be one of the best decisions you even make. Maybe the best.
If you get this decision disastrously wrong, well..your marriage will be miserable and your divorce will be expensive.
This is an A/F decision. Getting it right is about as good as it gets. Getting it wrong is worse than not deciding at all.
When it comes to finding a marriage partner, you can’t just put all the women you know into a bracket and start flipping coins. You need to come up with standards and ask yourself disciplined questions such as:
- Do we share similar core values?
- Are we able to align our priorities?
- Do we have compatible life philosophies/world views?
- Do we have a similar vision for what family life will look like?
- Have we each proven ourselves capable of sacrificing selfish interests for the sake of something bigger?
Notice that all of those were “we” questions that included you and not just your potential partner. Being ready to get married is just as much about being the right person as finding the right person.
Buying a House
Houses are expensive purchases that come with more expenses.
I’m not against owning a house. I own a house. But you have to realize that you are locking yourself into a major financial commitment.
Buying a house you can’t afford will put major strain on your finances.
What’s the worst case outcome? You could have your home repossessed. That’s a pretty bad outcome if you ask me.
Your housing costs are your biggest expense, and your choice of where to live drives other costs like furniture and utilities. It’s worth taking a lot of time to think about how much you can afford and how much cash you need to buy a house.
It’s also worth taking your time to find a good deal. I spent nine months looking for a house that I knew I could afford and would be happy to live in. It was a frustrating search, but it was a purchase that was worth taking the time to get right.
Investing in Speculative Assets
Your crypto investment could go to the moon. Or you could lose everything.
Whenever you have an outcome spread like that you have to be really careful. If you really feel the itch to get some exposure to outrageous upside, consider using the 90/10 rule to minimize your risk. Put 90% of your investment money towards boring investments like index funds, and throw 10% at whatever speculative opportunity excites you.
Be careful Crossing “C”
One way to further refine this framework is to grade the value of not making a decision at all as a C; the most mediocre grade in the book.
This way, when you are making a decision, you can ask yourself if there is the potential that you will cross the C threshold. In other words, is this the kind of decisions will leave you better off than not choosing and worse decisions will leave you worse off than not choosing?
A spread of possible outcomes that crosses C should be handled with care, although the principle still remains that a narrow spread warrants decisive action (e.g. a C+/C- decision is more important than an A+/A- decision, but not nearly as important as an A+/D+ decision).
Making better decisions is dependent on being able to identify what kind of decision you’re trying to make. Using the Outcome Report Card method you can quickly separate decisions that can be made immediately from ones that truly require careful deliberation
- Is Dollar-Cost Averaging Worth It? - March 27, 2023
- My Favorite Savings Account With Sub Accounts - March 20, 2023
- The Average 401k Balance by Age - March 13, 2023