The Matrix is a movie about finding the truth. The Matrix follows a band of freedom fighters as they battle a surreal establishment with nothing less than the future of mankind at stake. It’s a movie about good and evil, real and unreal, courage and fear. The movie is also about some really cool fight scenes. And for our purposes today, it’s a movie about making impossibly difficult choices. Watch this short clip (34 seconds) about a choice Neo (played stoically by Keanu Reeves) had to make, and then we’ll see what The Matrix can teach us about personal finance:
When making a personal finance or investing decision, have you ever felt like Neo? He recognized the seriousness of the decision. He recognized that he had to make a choice. And he recognized that there was no way to truly appreciate the consequences of his decision. In other words, he did not and could not know which choice was best.
So how did he choose between the red pill and the blue pill? One might say that Neo was born to make the decision he made. Others with a fatalistic bent, might say the choice was already made for him, and the suggestion that he was free to choose either pill was illusory. But let’s not venture that far into Wonderland. What about personal finance?
There are many financial decisions we all must make with less than perfect information.
Do we accept a new job that may be better than our current one, or stay put at a job that, while less than perfect, is not unbearable? How much of our 401(k) do we invest in the stock market, or small cap stocks, or international stocks? Do we buy a house now that prices have fallen, or do we wait to see if they will fall even further? Do both spouses work outside of the home, or do we sacrifice financially so that one of us can stay home with the children? These are not easy questions, and like the blue pill versus red pill, there’s no way to no the outcome of our choices until sometimes many years later.
So how do we make these tough choices? I wish I could tell you there was an easy answer to that question, but there’s not. I’ve struggled with the tough questions like everybody else. In making those tough choices, however, I do keep some things in mind. So here are some things to consider when confronted with some of life’s toughest questions:
- Acknowledge the limitations of your knowledge: Oddly enough, I’ve found it helpful to recognize that I can’t possibly know all of the ramifications of my decision. I need to recognize what I can control and what I can’t control. Focus on what you can control, and forget about the rest.
- Learn everything you can about the choice: Having figured out what areas of the decision you can control, learn everything you can about the choice you’re facing. If it’s investing in your 401(k), learn everything you can about asset allocation, for example. It may prove a bit overwhelming at first, but nobody said this would be easy. By the way, if asset allocation befuddles you, check out my Beginner’s Guide to Asset Allocation.
- Consider the worst case scenario: In the world of negotiation there is a concept called BATNA (Best Alternative to a Negotiated Agreement). The idea is to determine what your situation will look like if you don’t reach an agreement during a negotiation. This concept can be used in making just about any decision. Understanding the worst possible outcome of one decision over another will help you assess the potential risk of the decision. I did this when I quit a very good job after ten years to take a new job making one-third less. I wanted to spend more time with my family and try something new. The worst case scenario I imagined was being miserable in the new job or even being fired. While either outcome would have been difficult, I concluded that I would be able to find another job and that the risk was worth the benefits the new job offered.
- Get creative: Sometimes we are confronted with a choice that appears to have just two options. Either both spouses work or one stays home with the kids, for example. But there are other options. The second spouse can find a job working from home or perhaps work part-time. The point is that choices sometimes present themselves in ways that are less than ideal. Question all assumptions and look at the decision from multiple angles.
- Say ‘yes’ to all the options: Particularly when it comes to investing, the best choice among alternatives is to accept them all. In my investment accounts you’ll find U.S. equities, REITs, international developed country funds, emerging market funds, bonds, TIPs and cash. Why? Because I don’t know which asset classes will do best over the next 30 days, let alone the next 30 years.
- Don’t make difficult decisions before you have to: As Mrs. Dough would tell you, I’m prone to discussing and analyzing decisions long before they must be made. It drives her crazy. There’s nothing wrong with thinking ahead, but I take it to the extreme. But when it comes to making the actual decision, don’t make it until you have to. By this I don’t mean waiting to the last second to make a decision, but there is no reason to commit yourself to a course of conduct until you have to. By waiting, I’ve found that some decisions resolve themselves without any action on my part, and sometimes I learn new information that I can use in making the tough call.
So how do you make the tough decisions? If you’ve confronted an impossibly difficult decision, let us know how you made the choice and how it worked out for you.