How to Hone Your Financial Decision-Making Skills

This article is an excerpt from the Shortform book guide to "The Joys Of Compounding" by Gautam Baid. Shortform has the world's best summaries and analyses of books you should be reading.

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How good are your financial decision-making skills? Do you have trouble settling on a purchase?

In The Joys of Compounding, Gautam Baid recommends sharpening your decision-making skills to excel in the world of investing. With the right approach, you can navigate the market’s intricacies, ensuring you distinguish between monetary market blips and significant changes.

Here’s how to improve your financial decision-making skills so you can be an investing expert.

Enhance Decision-Making Skills

Baid offers the following suggestions to hone your financial decision-making abilities:

Think rationally: Base your decisions on logic and research rather than on emotions or biases that may cloud your judgment. This ensures you won’t be swayed by herd mentality or volatile market movements.

(Shortform note: Rolf Dobelli (The Art of Thinking Clearly) offers practical advice for thinking rationally. First, familiarize yourself with common cognitive biases, such as confirmation bias (favoring information that aligns with your pre-existing beliefs), and emotional triggers like excitement from recent successes or fear from recent failures. To counter these influences, actively seek out evidence that contradicts your initial judgments and emotions. For example, if you’re excited about a company’s prospects and focus solely on positive news to support your judgment, you’re succumbing to confirmation bias and emotion. Counter this influence by also researching the company’s potential risks before making an investment decision.)

Follow predetermined criteria: Make checklists to guide your investment decisions. This ensures each choice undergoes rigorous evaluation and reduces the chance of oversight or impulsive actions.

(Shortform note: Experts suggest there are seven key things to factor into checklists to make informed decisions: Explore potential benefits (such as high returns), assess potential risks (such as market downturns), consider alternative choices (such as diversifying into emerging markets), reference prior similar situations (such as past stock market trends), analyze relevant data (such as company financials), understand stakeholders’ perspectives (such as shareholder opinions and economic forecasts), and ensure alignment with values and long-term goals (such as by investing in meaningful causes and considering pension growth).)

Evaluate financial advice critically: Question guidance from financial consultants, understanding that their interests might sometimes diverge from yours. Always seek alternative viewpoints before making definitive decisions. (Shortform note: Expanding on this, Tony Robbins (Money: Master the Game) explains that financial consultants aren’t legally required to prioritize your interests and, given that many operate on commissions, it’s in their best interest to sell you more expensive services. Beyond seeking alternative viewpoints, Robbins suggests you can avoid potential conflicts by employing a fiduciary, a financial professional legally bound to act in your best interest. Fiduciaries receive fixed compensation rather than commissions.)

Update your knowledge: Keep informed about market shifts, global economic changes, and industry-specific trends. A well-informed stance enhances your ability to spot potential opportunities and adapt to market fluctuations. (Shortform note: Finance experts offer practical methods for staying up-to-date with market movements, including two key strategies: Follow news aggregators, such as Google News, to stay aware of pertinent investing reports from a wide array of sources and to ensure you don’t miss market developments. Also, leverage social media by following influential financial analysts or monitoring hashtags related to market trends to access real-time insights and discussions about securities markets.)

Maintain a journal: Record each of your investment decisions, the rationale behind them, and the results they yield. This reflective practice offers clarity on past choices and provides insights for shaping future strategies. (Shortform note: Some finance experts echo this advice, suggesting that this practice helps you evolve as a more informed investor. They offer practical advice for maintaining your journal. Begin by recording your short- and long-term investment goals. With each investment consideration or decision, go deeper than just numbers; explore your underlying beliefs, market perceptions, and any hesitations. Periodically, revisit these reflections to look for patterns, biases, or even evolving investment philosophies.)

Define and monitor your financial targets: Set clear objectives for each investment and periodically compare your portfolio’s performance to these benchmarks. This ongoing assessment helps fine-tune your approach and adapt your strategy when necessary. (Shortform note: Morgan Housel (The Psychology of Money) points out another benefit of defining financial targets: It helps you ignore irrelevant information that might lead you to make poor decisions—for example, being influenced by what others do or getting caught up in investment bubbles. On the other hand, clearly defined targets focus your attention only on information relevant to your financial goals, enhancing your decision-making process.)

How to Hone Your Financial Decision-Making Skills