BALANCE: THE CLASSIC CASE OF RISK VERSUS REWARD, PART 1

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DETERMINE THE REAL COST BEFORE YOU DECIDE

You wouldn’t think of buying a car without knowing its price tag, but a lot of people make big decisions, including very important life decisions, without understanding the real cost.

Balance is the one of the four cornerstones of great decision making because it forces us to look at the equality or inequality between the risks and the rewards in any given situation.

Of course, cost is not only measured by money. Cost also involves your time and emotional wellbeing (stress). Consider the potential cost of marrying the wrong person, pursuing the wrong career, or staying in the wrong job too long. The consequences would be life-altering.

Using Balance in your decision-making process involves more than writing down a list of risks and rewards off the top of your head. In conjunction with the rest of the framework outlined in Never Be Wrong Again: Four Steps to Making Better Decisions in Work and Life, Balance will help guide you to the best decision possible.

To help you assess the Balance in your next important decision, follow these three steps:

Step 1: Determine Your Risk Limits
Before weighing the Balance in your decision, you first need to determine how much risk you are willing to take, and commit to sticking to your risk parameters.

BEFORE you even begin to look at the cost-to-benefit ratio, decide your non-negotiables the amount of risk you will not accept under any circumstances.

Example:
No one loves paying insurance premiums. If you own a home and are not required to buy homeowner’s insurance, would you be willing to risk losing your home to a catastrophic accident in exchange for the benefit of not paying insurance premiums? Most people would consider this an unacceptable risk because the potential loss is too great.

Unacceptable risk is unique for each individual, but whatever it is for you, know it, and don’t cross that line.

Step 2: Get Real
Now that you have determined your risk limits, the next step is to assess the real potential costs.

Research shows that most people become enchanted with the ultimate rewards and tend to gloss over the concomitant risks. This is a classic case of “confirmation bias,” where we only seek out data and thoughts that confirm our initial gut reaction instead of actually challenging ourselves to think through the decision.

If you want to leave your job to start your own venture, you should fully understand the potential costs before you give notice. All success comes with some risk, but you need to be realistic about the potential risks and balance them against your assumed rewards, which should be supported by real data.

Step 3: Make a NEW Decision (Every Time)
Important decisions made long ago should be reevaluated if you are still acting on them.

All decisions are forward looking, which means, every decision is a new decision. A decision to keep doing things the same way you have always done them is still a new decision!

If you originally decided to not quit your job but continue dreaming of entrepreneurship, reevaluate your data every so often and make a new decision each time whether to stay in your job or not. (Making a conscious choice to stay in your existing job can actually be empowering.)

On the other hand, if you did quit to start your own gig, you should occasionally revisit that decision to be sure you are on track toward achieving your ultimate goal. (See my upcoming Probabilities blog for more on goals.) If two years into the business, you are still not seeing the profit you envisioned, use the decision-making framework to make a new decision about whether to continue on your current path and for how long.

BONUS: Beware Of These Common Pitfalls!
“Sunk cost fallacy” and “creeping risk” are two enemies of good decision making. Do not fall into their traps!

Sunk-Cost Fallacy
People hate losing. We are hard-wired to avoid loss, so all too often we continue investing time or money into something to avoid facing the losses we have already incurred. Instead, we make riskier bets to postpone having to admit our loss. Sunk-cost fallacy is the basis for the old expression “throwing good money after bad”.

If you have invested substantial time and money into a project that is not paying off, don’t try to salvage it for emotional reasons. Choose whether to put in more money and time based on the facts you have, not the ones you wish you had.

Many decisions are like a poker game. You are dealt a hand and make an initial bet. When you are dealt new cards, your hand changes and you might want to make a different bet. When it’s time to fold up your cards, the amount of money you spent on the prior bets is irrelevant. You have already spent it and can’t get it back.

Creeping Risk
Don’t let numbers fool you! While we all know that people can intentionally or accidentally mislead you, so can numbers.

When I ask audiences, “Who would like to earn a 10% return on their investments instead of a 5% return?” all hands go up. I remind them that there is an increased risk here. Nearly everyone is comfortable with the idea of taking 5% more risk, because 5% doesn’t seem like much. But the number is misleading. In reality a 10% return is actually twice as good (100% better) than 5%, which means that the 10% risk is double the 5% risk. When I reframe the question and instead ask, “Who would like to take 100% more risk in this turbulent market?” almost no hands go up.

“Creeping risk” is a common problem for entrepreneurs. Reexamine the risk you are willing to take, especially when the risk now is greater than the original risk you signed up for.

Recap
Balance is an important part of decision making that looks at the potential costs you are willing to accept in exchange for the rewards you seek. To use Balance in your favor, beware of “creeping risk” and “sunk cost fallacy,” establish and stick to your risk thresholds, be realistic about both the perceived benefits and risks, and treat your ongoing decisions as new decisions each time. Your result should be a choice that puts the balance in your favor.

In my next blog, we will look at the not-so-obvious side of Balance —
Gut Instinct vs. Data. Which is best? (HINT: This is a trick question).