Financial Decision making for Managers

Smart decisions rely on solid foundations

We apply a number of decision “principles” to help guide our clients’ wealth management success.

Many are based on research from the fields of economics, psychology and decision making analysis. Others, however, reflect how we look at things, driven by both our values and experience. While these principles are focused on wealth management issues, most of them have much broader application.

Some key principles that we think will help you make better decisions are discussed below under the following headings:

1. Understand opportunity cost

Opportunity cost is an important concept in economics. It says that the cost of any action is not the direct cost incurred in taking that action but the highest value alternative action you choose (perhaps, unknowingly) to forego. The decision rule that applies is that you should only choose actions that have benefits in excess of their opportunity cost.

Let’s make that a little more concrete with an example.

Assume a surgeon wishes to have a brick wall built at his residence. A bricklayer, costing $50/hour, could build the wall in one hundred hours for $5, 000.

However, the surgeon is a capable bricklayer – he could do the work in one hundred and fifty hours. So he takes three weeks off work, builds the wall and saves himself $5, 000. But has he really?

In his medical practice, the surgeon can earn a net $300 per hour or, say, a total of $45, 000 over three weeks. The surgeon’s opportunity cost is therefore $40, 000 in excess of the benefit of building the wall himself. He should choose to hire the bricklayer, rather than give up his day job!

Application of this principle implies that it does not usually make economic sense for most people to become amateur financial planners or wealth managers. This does not mean that you abrogate responsibility for your financial affairs but rather that you should focus on what you are best at to increase the likelihood you will achieve what is really important to you in life.

“... from the standpoint of building wealth, free time is better spent sharpening one’s professional skills rather than studying investing.”