As an investor or policy maker, you are constantly busy making decisions: which strategy do I follow, which risks do I want to accept or not, how do I position my portfolio, and so on. Since nobody can predict the future exactly, the circumstances under which decisions are made are always uncertain.
Decision-making therefore requires careful consideration of the pros and cons of each decision. Making such assessments is therefore a core task for policymakers.
But as most people probably know, making decisions is often difficult. Who has not regretted a choice? The more important question is whether, when you have regretted a choice, you have also looked at how it could have come to this. Because if the quality of decision-making is good, the risk of hassle afterwards can be limited.
Striving for a high quality of decision-making does not mean that every decision was the right one in hindsight, given the uncertain circumstances. But it does ensure that your decision is well-founded, regardless of its ultimate consequences.
Quality of decision-making
To achieve good quality decision making, we distinguish three components:
High quality input:
Documents, analyses etc. on which the decision making is based should be complete and correct, for example because all relevant risks have been identified and weighed. This also includes the quality of any quantitative models used in the analyses.
Drafters are to a large extent independent of the decision makers, so that one avoids talking down to the decision maker.
High quality of decision-makers:
The quality of the decision makers constitutes the human side in decision making.
Above all, a high quality decision-maker is able to assess the quality of the input and to counterbalance, for example, advisors, customers and regulators.
A high-quality decision-maker is open to the suggestions of others, but will never hide behind them.
The decision-maker is not guided by the various biases from behavioural finance, such as overconfidence and loss aversion (see for example Ritter, 2003).
High-quality process:
A thorough process ensures that the decision-making process is logical and supported. This includes ensuring clear steps in the process (vision, judgment and decision-making), but also ensuring that all perspectives (and decision-makers) receive adequate attention, such as second-line risk opinions.
By process, we also mean a culture in which people are allowed to voice dissenting opinions, without being held accountable.
More than the sum of the parts
As can be seen, the three parts are not a sum, but a product: this means that the parts are not independent of each other, but can strengthen or weaken each other: a bad score on one of the three parts can already have a large negative impact on the total quality of the decision-making. In a chaotic (i.e. low-quality) process, there is a greater risk that input will be incomplete, leading to important arguments being missed and incorrect decisions being made (“panic football”).
At best, high quality will prevent inadequate quality from resulting in inadequate quality decision making elsewhere: a high quality decision maker (person) will recognise inadequate quality input and thus not take the decision, but first improve the quality of the input. Similarly, a sound process can provide the necessary checks and balances on the quality (and biases) of the decision-maker and input, reducing the need to lean on the quality of the decision-maker.
I challenge you to assess yourself and your decision making process on the above elements and wish you good luck with improving the quality of your decisions.
Edwin Massie is senior consultant Pensions & Insurance at Ortec Finance, a global provider of technology and solutions for investment decision making.