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How to use graphics to explain complex economic relationships

The world of business and finance are filled with numbers, and often filled with fairly complex mathematical concepts in probability, statistics, game theory, and operations research. This is true in just about any enterprise, and is especially true in those kinds of large-scale activities that support basic services in large metropolitan areas.

Dealing with garbage and recycling are one of those kinds of activities that every community has to deal with, and for larger communities it often involves many issues ranging policy making, taxation, electoral politics, and long term planning. Because of the policy and political aspects of these kinds of endeavors, it is vital that every stakeholder in the affected communities have at least a basic understanding of the scale and scope of what that community faces.

When it comes to these kinds of ongoing issues, anyone who is interested in affecting the outcome of the decisions that have to be made should embrace any tool that will help stakeholders and decisions makers agree to their point of view.

One example is the following graphic called the Secret Life of Garbage. A colorful and well-designed graphic like this may not immediately change hearts and minds about how to deal with garbage, but it would almost certainly encourage people to learn something about the issue.

Life of Garbage
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Relationship between golf technique and financial decision making

Anyone who makes an argument that understanding golf techniques can help the average person with financial decision making is either a golfer who wants to find a justification for their hobby or someone hoping to market financial education to golf fanatics. Both are true for the writer of this article.

Take the example of deciding whether to invest in a particular opportunity. One way to organize and evaluate that decision is to split it into four parts: (1) the project, (2) the financing, (3) the partners, and (4) the management. If you don’t understand one or more parts of this situation, or see a potential issue in one of these four areas, it may be very unwise to move forward.

On the golf course, with a bit of a stretch of the imagination, you can use the same model to decide whether to go out and enjoy a round of golf. Two of these areas are very easy to understand. If the financing isn’t in place (green fees, babysitter, food and beverage costs, tip for the caddy, reserve for lost bets), or if you really don’t want to golf with the other people in your party (for example a client that you can’t stand), then staying away from the links may be a good idea. Of course, if the project is attractive enough (a round a Pebble Beach, golfing with a US Senator), you may find the resources and motivation to deal with the partner and financing issues.

The hardest thing in both financial decision making and golf is management. In business, while you should have at least of basic understanding of how to manage the investment, you often have the option of evaluating an outside manager or management group to take over many and perhaps all management aspects of your investment. That option doesn’t exist in golf.

In managing one’s golf game, some things like deciding what shots to take in a particular situation is a function of experience, with the decisions often getting better over time. Other things, like golf technique, also depend on experience, but are affected by the the quality of the formal training you get, or the kinds of advice you may get, especially from an experienced golfer like Neil Haboush. As is the case with financial decision making, the best advice may not come from someone with the best textbook or theoretical knowledge, but from someone who has been out there in the middle of if all an knows from personal experience how to get out of a bad situation.

Problem 3: Not Looking at All Sides of a Problem

This problem is usually having a point of view on an investment situation where you may have taken someone else’s word on it or never really given the question serious thought. One common financial example of this the use of a financial advisor to assist you in buying and selling stocks, mutual funds, or other investments. Whenever I consider that advice from this kind of source, I ask several questions about the source of the advice. Some basic ones may include the following:

– Does this advisor have anything to gain or lose by my decision?

– Is this advice based on the advisors own expertise or on someone else’s?

– Is this person following their on advice on that issue?

– Is the advice based on a fair analysis or a biased analysis?

– Is it to my advantage to even consider taking this advice?

– If the advisor makes any performance claim, can the claim be backed up?

– Does the advice make sense?

– After further investigation and research on my part, does the advice still make sense?

– Does not following the advice make better sense?

The current rash of mortgage problems in the US, issues like short sales because of underwater mortgages and foreclosures, is one example of this kind of decision problem in action. Many people got into this situation because they didn’t think about the consequences of taking out a home equity loan to buy expensive toys, or the possible negative consequences of an adjustable rate loan.

There are many more questions that one can ask, but the basic point is that every decision can be looked at in more than one way. It is to your advantage to ask a few questions and do at least a little work to understand what may be behind a piece of advice.

Next Lesson: Being Overconfident In Your Predictions

Money Decision Problem 2: Solving the Wrong Problem

You can have the greatest system in the world for analyzing and solving your personal or business money problems, but you would be wasting your time if you were solving the wrong problem. This usually happens if you do not think through a problem before you start to solve it. To understand how to approach a particular problem you should understand at least these things about the problem:

  1. What are the limits to problem at hand?
  2. How do you define a good or a bad outcome to the decision?
  3. How should you measure the outcomes?
  4. What do you bring mentally and psychologically to the decision table?
  5. What are other ways to look at the problem?

A Mutual Fund Example
One example of solving the wrong problem is to pursue a high rate of return from a mutual fund investments without first deciding what kind of comparison or benchmark you should use to determine if the return is high enough. For example, index mutual funds that are designed to mirror the results of the Standard and Poor’s 500 index consistently outperform rough 80% of all mutual funds. The original problem may have been how to choose mutual funds with high returns. A better problem to solve would be how choose mutual funds which consistently perform better than the S&P 500.

Final Thoughts
Remember that most problems involving money usually involve something else besides money or mathematics. If you focus on the parts of the problem that are objective and that can be measured or solved with common with equations and spreadsheets, you may miss the most important part of the problem.

Next Lesson: Not Looking at All Sides of a Problem

Money Decision Problem 1: Not Taking the Time to Think About the Problem

Money Decision Problem 1: Not Taking the Time to Think About the Problem and the Decisions that Must Be Made

Before you make a financial decision, you have to know something about your needs, the effect your decision may have, and how you go about making a decision. Some common money decisions that often happens too quickly is what credit card you should have, whether to buy or sell a stock, or whether to go into debt to replace your boring old (and paid off) car for a shiny new one. Taking the time to make a proper decision can save you a lot of frustration and regret, especially if you do it consistently.

A Credit Card Example
Let’s look at the credit card situation more closely. There could be dozens of reasons why you suddenly decide that you need a new credit card. You might not have one at all, but one day you decide to rent a car and find out that you need a credit card. You might have a card already, but you find a way to transfer balances and reduce your interest rate for the first six months. Even if you think you need to take action right now, it always makes sense to think it through to see if it is the right decision for you. The following are just some of the questions you should ask yourself before you sign on the dotted line:

  1. What do you want to accomplish when making the decision? – At the very least, figure out if it is a short term or long term goal.
  2. Who will be making the decision? – Typically anyone who will be responsible for paying the bill and whoever will be allowed to make charges on the card.
  3. How should the decision be made? – Figure out things like whether you need to decide after comparing other options, or if any one person will have veto power.
  4. Does the decision significantly affect other decisions?
  5. Does the decision have to be made at all? – Think about what would happen if you took no action.
  6. Does the decision have to be made by some kind of deadline?
  7. What’s the worst that will happen if you don’t make a decision?
  8. How much time do you need to make a decision?
  9. What kind of options do you have?
  10. Do you have any experience making this kind of decision, and if so what did you learn?

Once the background questions are settled and you have a good understanding of your overall situation, you have to start dealing with the decision making process. You should finish gathering any information that you need to make a decision. For credit cards, this would be things like late fees or other penalties, how much interest you will be charged, and what kind of no-interest grace period you have. These kinds of details should be spelled out in the agreement. If you don’t understand it, don’t sign it. If you don’t see it in the agreement, then it’s not part of the deal.

The next big steps are making the decision and carrying it out. If you decide to do something, then follow through. If you decide to do nothing, then take no action, no matter how tempting it may be. If you decide to change your mind, go through the same decision process. Don’t make the mistake of being logical and systematic the first time through and then being very informal the second time you wrestle with the same decision. Every decision is a combination of your analysis and your judgment. If you have a consistent process, you’ll likely improve the quality of both your analysis and your judgment.

Final Thoughts
Keep in mind that a credit card can turn out to be a long-term relationship. If you pay your bills in full every month, it can be a very happy and harmonious relationship. If you fall behind, it can turn real ugly real quick.

Next Lesson: Solving the Wrong Problem

Making Money Decisions

Do you every wonder about your ability to make good decisions about money? Do you think you need to know something special to be better than average? Before you got that seminar, buy that book, or sign up for that MBA program, you should take some time to look at how you make money decisions. Success in investing, or choosing the best mortgage, or picking a sensible credit card all starts with using your mind to figure out your options and to make decisions.

The Making Money Decisions posts will take you through a few basics of decision making and take some of the stress out of making decisions about your money.

The ability to make good decisions is as skill that can be improved through practice and the use of the proper techniques. None of these techniques are based on any sophisticated mathematical or psychological concepts. If anything, the basic techniques of decision making are about figuring out what information you need for a decision, making a clear decision, and checking up on the results afterward. It is about finding the proper balance between intuition and analysis and recognizing that you can develop all the decision making skills that you need to become a better investor.

Next Lesson: Taking the time to think about your money problem