All You Need To Know About Financial Decisions

Having a solid financial plan is only one aspect of becoming a successful investor; mental toughness is another. You risk making emotional investing choices if you are not conscious of your prejudices and weaknesses. These choices may lead to lost investment opportunities as well as underperforming investments.

We’ll talk about financial decisions, types, and strategies in this blog to help you make better financial decisions.

What is the financial decision?

Making decisions on how to allocate, manage, and use financial resources in order to reach financial objectives for oneself or a business is known as a financial decision. To maintain financial stability and growth, it entails weighing many options pertaining to borrowing, investing, saving, spending, and risk management.

Types

Three primary categories of financial decisions exist:

• Investment Decisions: Also referred to as capital budgeting, investment decisions entail deciding how best to distribute financial resources in order to maximize returns. These choices include deciding between several investment options including stocks, bonds, real estate, or growing a business. The objective is to efficiently manage risks and guarantee long-term profitability. When choosing an investment, factors including risk assessment, market conditions, and expected returns are quite important.
• Financing Decisions: How a company or individual gets money to support operations and investments is the main focus of financing decisions. This entails deciding between several funding options, including debt (bonds, loans) and equity (issue shares, venture capital). Cost, risk, and financial flexibility must all be balanced in the decision. For businesses to be financially stable and grow, they must maintain an ideal capital structure, which consists of a balance between debt and equity.

Choosing how much of a firm’s profits to distribute to shareholders as opposed to reinvesting in the company is the subject of dividend decisions. Businesses must choose between retaining earnings for future expansion, paying out large dividends, or finding a balance between the two. The profitability of the business, expansion goals, shareholder expectations, and market conditions are some of the factors affecting this choice. Good dividend policies ensure long-term company growth while preserving investor confidence.

Advice for Making Wise Financial Choices

The following advice can help you make wiser financial decisions:

Chunking is the process of dividing large tasks into smaller ones.
Almost everyone has the desire to be wealthy, but figuring out how to get there can seem like a difficult undertaking. Here’s where chunking can assist you divide the ultimate objective into more doable, smaller tasks.

Let’s say, for instance, that you invest in stocks. You don’t have to be an expert in the stock market to make your first investment. Before making your purchase, you may instead concentrate on a much narrower area of the stock market and thoroughly research it. Similar to this, before making your first investment, you can concentrate on a certain area or industry, such as banking, insurance, metals, etc.

This chunking technique can help you reach goals that may initially seem daunting by breaking down not only your financial situation but also your career and personal objectives. The table below demonstrates how chunking can assist you in dividing the difficult task of generating Rs. 1 crore year into smaller, more doable tasks:

As you can see, chunking allows you to divide the difficult goal of earning Rs. 1 crore into smaller, more manageable goals.

2. Reframing: Examine An Alternative Viewpoint

You must examine the existing circumstance from a different perspective in order to master the art of reframing. You may be able to evaluate the situation differently as a result of this shift of viewpoint. By completing this process, you can discover other options that might not otherwise be readily apparent.

Let’s say, for instance, that you own a building with an antiquated elevator. Your initial instinct might be to replace the outdated elevator or figure out a method to make it faster if you have repeated complaints about it being too slow.

You can now reframe the issue and approach the elevator’s unavailability from a different perspective rather than choosing this apparent fix. After rephrasing, you may discover that, because all tenants share the same lunch hour, elevator traffic is at its peak during that time. This viewpoint may result in a different approach, such as requesting the tenants to space out their lunch periods to minimize elevator traffic at particular times of the day. Installing a screen that shows news updates in front of the elevators could also be a way to improve the wait experience.

3. Creating Fear: Getting Ready for the Worst-Case Situations

Although optimism is frequently the best course of action, fear setting has the opposite effect. In a fear-based environment, you must think that you have committed a mistake and then make yourself consider every possible outcome. This worst-case scenario analysis can assist you in seeing possible issues and taking action before they arise.

Tim Ferriss’s seven-step fear setting framework is one way to incorporate fear setting into your decision-making process. This is how this seven-step framework appears:Step 1: Describe the worst-case situation
Step 2: Determine how to fix the harm
Step 3: Which situations are more likely to occur?
Step 4: How would you regain financial control if you were fired today?
Step 5: What are you avoiding because you’re afraid?
Step 6: How much does delaying the action cost in terms of money, emotions, and physical health?
Step 7: What’s the hold-up?
This exercise highlights the natural fear responses you may have when something goes wrong, but the first step to overcoming these concerns is to recognize them early.

4. Mistake Board: To Recall and Gain Knowledge from Your Errors

We all make mistakes, yet we frequently forget what we’ve done wrong. This makes it more likely that the same error will be made again. Making a wall of shame or mistake board is one technique to make sure you remember and grow from your mistakes. This might act as a reminder of your errors, preventing you from making the same ones again.

You can include the following mistakes as examples on your mistake board:

• Too early or too late to sell a stock
• Purchasing a costly endowment policy or ULIP
• Using stock recommendations to make poor investment decisions
• Putting money into futures and options without knowing how they operate

A framed replica of the error board could serve as a useful reminder, but you can also adopt a more subdued strategy. You can also accomplish the same goal by, for instance, keeping a scrapbook or journal in which you record the investing errors you have made.

5. Inversion: Reverse Engineering the Final Outcome

The renowned German mathematician Carl Gustav Jacob Jacobi developed the idea of inversion, or working backward to arrive to a solution. Although it may appear contradictory, the idea of inversion can be a useful tool for resolving a variety of financial issues. Although putting this strategy into practice may not be simple, done right, it can help you steer clear of a lot of typical investment blunders.

To put inversion into effect, for instance, think about the question: How can I increase my income? Once inversion has been applied, the question will shift to: How can I ruin my finances? You will find yourself thinking in the complete opposite way and coming up with a distinct set of solutions that can be just as successful in achieving your objectives if you think about the inverted issue.

The main advantage of inversion is that it pushes you to think creatively and challenges your preconceived notions. Over time, consistent inversion practice can result in major improvements to your personal and professional lives as well as your financial situation.

6. Statistical Analysis: Adopt a Statistical Mindset

Let’s say a 95-year-old man smoking a cigarette appears on an anti-smoking campaign poster. Given that a heavy smoker has lived a long life, your initial thought upon seeing this image may be that smoking cannot be all that harmful. However, the message of the anti-smoking ad is different: smoking kills. So how can we make this message clearer and easier for the intended audience to understand?

Thinking like a statistician might be one method to do this. Let’s say you choose 1000 people, each 95 years old, at random from a sample of 1 million smokers and 1 million non-smokers. Given that nonsmokers often live longer than smokers, it seems likely that the majority of these 1000 people will not smoke. Even if the sample size were increased to, say, 1 million people 95 years of age or older, the majority of them would still be non-smokers.

You can resist the inclination to take extraordinary events as the norm by adopting a statistician’s perspective. Ultimately, exceptions do not accurately reflect reality. Additionally, this can help you avoid falling victim to mis-selling.

When it comes to investing as well, we frequently have a tendency to concentrate on extraordinary occurrences, such as a stock price that rises 300 times in a year or an investment of Rs. 1 lakh that increases to Rs. 46 lakh in a matter of months. These dramatic occurrences are typically anomalies, and they can mislead many people into believing that high-risk investments, such as penny and micro-cap stocks, can yield large returns quickly. In actuality, there are over 1000 stocks that have completely flopped for every multi-bagger that has been profitable. Only by adopting a statistician’s mindset can this fact become clear.

7. The” This happed Because.”

Method Examine the Abecedarian Reason Charlie Munger, the famed investor, loved using the” This happened Because.” system. Munger does not worry about a 10 reduction in the price of one of his stock investments; rather, he looks for the beginning reason why it happed in the first place.

High valuations, stockholder herd intelligence, geopolitical threat, and other factors can each contribute to a decline in share price. Investors can make better opinions about whether to hold or vend a certain investment by knowing the underpinning cause. also, you may be in a better position to make long- term investing opinions that yield significant returns if you steer clear of the herd intelligence and borrow a contrarian perspective.

The bottom line

The purpose of each of the seven mental strategies covered above is to encourage you to think creatively and beyond the box.

Chunking, for instance, can assist you in dividing a big, difficult activity into manageable portions. Then, you can solve the problem more effectively by reframing it. A variety of issues that may arise in the future can be identified and planned for by considering worst-case scenarios and potential solutions. Analyzing “why it happened” can help you identify the underlying reason for an investment’s underperformance or failure, and thinking like a statistician can help you sort through the noise.

You can enhance not just your financial decision-making but also your professional and personal decision-making by putting these seven special mental tricks into practice.