Reed C. Fraasa, CFP®, AIF®, RLP®
Where is the wisdom we have lost in knowledge?
Where is the knowledge we have lost in information?
T.S. Eliot, The Rock, 1932
What does Eliot’s critique of modernity, which holds that we are losing something valuable in our lives as we pursue technical progress, have anything to do with investing and personal financial planning?
I started in financial services in late 1989. The firm where I worked had one personal computer that operated programs from a large floppy disk. There was no internet, CNBC had just started, but nobody watched it, a few monthly periodicals like Money magazine existed, and 401(k) plans were gaining popularity. Most people checked their investments once a month or once a quarter, read newspapers, and watched about one hour of news a day.
Now, thirty years later, we have 5G internet and personal computers in the palm of our hand, cable news broadcasting financial and political information 24/7, and Twitter and Instagram feeds. People can check their investments minute by minute. And, for the first generation in history, the average person has more wealth in their 401(k) plans than in their homes and property. The result of thirty years of progress is the exponential increase in the amount of information available to the average person.
Does more information help us make better decisions?
I have not observed that the growth of technology and connectivity, enabling instant and unfiltered dissemination of large volumes of information, has made the average person feel any more confident in their decisions.
Research overwhelmingly shows that too much information leads people to either not make a choice or to make worse choices. Google the phrase, “does more information lead to better decisions,” and you will see 591,000,000 results on the topic related to decision making with the first ten pages referencing dozens of research papers on the diminishing value of too much information.
Law of Diminishing Returns
In economics, the law of diminishing returns explains how increasing the amount of a single factor can reduce productivity. Wikipedia defines the law of diminishing returns as, “the decrease in the marginal output of a production process as the amount of a single factor of production is incrementally increased, while the amounts of all other factors of production stay constant.” We use this concept when we say that just because a little bit of something is good, that doesn’t mean a lot of it is better. Adding salt to a recipe is a good example.
Prudent Financial Decision Making
How we choose to interact with and consume information can have a significant effect on how we make and live with our decisions. Prudent decision making is critical to managing investments and personal financial planning, especially in times of turmoil like we are experiencing now. A prudent decision is one that equally considers the current and the future consequence of a choice.
Researchers at Cornell University estimated that the average person makes about 35,000 choices a day or roughly one decision every two seconds. Most choices we make are unconscious. The process of getting dressed in the morning involves so many choices like how you open a drawer, pick up a shoe, stretch, looking to the left or right, step into pants, and put on a shirt – most of which are unconscious choices requiring very little thought. Many other choices we make do require a thought process, a prudent process.
Employing a prudent process for thoughtful decisions can significantly influence our future outcomes. Where we find ourselves today is the culmination of thousands of choices we have made in the past.
4 Step Process to Prudent Management Decisions
To change our future, we need to be mindful of the future we desire and follow a prudent process. The Center for Fiduciary Studies defines a four-step process for prudent management decisions.
Organize
Formalize
Implement
Monitor
As fiduciary advisors, we follow this process in the planning and advice we offer our clients, and we also follow this process in the way we run our business. The first step in the process is to Organize. An essential process in organizing is to clarify your belief system. The structure of a belief system is like the hierarchal pyramid below with wisdom being the foundation, then knowledge, and finally, information. Notice the scale and importance of information in the structure.
Wisdom is the quality of having experience, knowledge, and good judgment; and wisdom, or the lack thereof, influences how we respond to uncertainty – the enemy of good decision making.
Knowledgeis the fact or condition of knowing something with familiarity gained through experience or association. We only need one experience of touching a hot stove to gain knowledge that stoves can be dangerous and hurt us. We gain knowledge through association from our family and social environments and when we read a book or hear a speaker.
The ancient Greeks had two words for knowledge, gnosis and epignosis. For example, gnosis is knowledge we gain from reading an instruction manual on how to assemble a bicycle. Once we understand the instructions and then actually assemble the bike, we have epignosis - the full, experiential knowledge of assembling a bike.
Information is a unit of data that helps us understand and accept knowledge. A little information can help us make better decisions; however, many academic studies have shown that too much information is likely to cause us to lose confidence and start second-guessing ourselves.
An example is two employees work for different companies that offer a 401(k) plan. One employee’s 401(k) plan offers 50 different investment options, and the other employee’s 401(k) plan offers five different investment options. Research has shown that the employee with five options is far more likely to make better choices to diversify their investments and have better results than the employee with ten times more options. Too much information can increase the amount of uncertainty, which can lead to indecision.
We are particularly vulnerable to uncertainty when we overwhelm ourselves with too much information, rather than relying on a foundation of wisdom. In the absence of a reliable belief system, we may fill the void with an abundance of topical information.
Our belief system will look like the inverted pyramid – precarious and subjective, and more likely to result in bad decision making. Have you ever noticed that if you search the internet for what you fear, you will find an almost limitless supply of information to support your fear?
How often do we take an equal amount of time to search for the opposing view? Being wired to identify threats in the patterns of information we receive, our brains are less likely to pursue knowledge that breaks those patterns. More on this later.
Over the next three weeks, I’ll explain how we can develop a system to cope with uncertainty in our financial lives built on a foundation of wisdom, how to draw on our collective financial knowledge, and finally, how to manage the myriad of information to achieve better decision making.
Author’s Bio
Reed C. Fraasa is a CERTIFIED FINANCIAL PLANNER™ and founder of HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Reed has 30 years of experience as a fiduciary advisor and is the author of The Person is the Plan®, a unique financial planning process. Reed was a frequent guest contributor on PBS Nightly Business Report and has been featured in the New York Times, Wall Street Journal, and Star Ledger newspapers.