Before the beginning of every semester during college, a couple of buddies and I would head off to Atlantic City. We were all Delaware football players, and they were on scholarship, but I was a walk-on. However, The Bill Long Scholarship paid the same expenses as a UD athletic scholarship — room, meals, and tuition — but not books. My father expected me to pay for those myself. After paying for gas, I put $30 in my pocket, and off I went to win enough money to pay for my books each semester. If I lost money, I checked books out of the library. It was a risk because library books needed to be returned each month, and if someone else wanted the book, I couldn’t check it out again. The pressure was on because I wasn’t smart enough to get through my classes without books. Some people are. Not me.
I played blackjack because it was the only game I understood. Also, I figured dealers were at a disadvantage because they had to hit on 16 and stick on 17. I had choices available that the dealers didn’t have. I could hit, stick, double-down and even split my hand. I started at the $5 tables, and if I won, I moved over to the $10 tables and so on. However, every hand presented a decision option where I had to choose from those aforementioned options. My decisions in Atlantic City all but determined my grades each semester. Luckily, I checked books out of the library for only one semester, and I’m proud to say I have more of the casino’s money than they have of mine. Truthfully, it was a straight cash transfer from Atlantic City casinos to the University of Delaware bookstores. I quit once I had won enough money to cover my textbook costs.
I haven’t been back to Atlantic City since my Delaware undergrad days, but I’ve often thought about those decision experiences. What influences a person to hit or stick? Why do people stay at a party too long? Why do people stay in relationships too long? Or why do they give up on them too soon? I worked with NASDAQ traders early in my consulting career. They all had entry and exit points, but they missed them. That’s why they called me. Like Mike Tyson said, “Everybody has a strategy until they get hit in the mouth.” Stress has a significant impact on not only how people make decisions but how they execute decisions. I worked with a private equity managing partner who completely avoided the decision issue. He simply didn’t engage by passing on buying opportunities and ignoring any entry points. His partners couldn’t understand why he passed on opportunity after opportunity costing millions of dollars. Fortunately, he acquired two companies within six months after we worked together.
The Cost Paradox becomes evident when determining whether to persevere or quit. How do we know if we’ve invested too much or not enough? There is no objective answer to this question. The problem is the Fear of the Unknown. We assign familiar triggers to predictable events, but we have no idea why unpredictable events occur, increasing our resistance to change.
The Fear of the Unknown is a two-sided coin. On one side, people overvalue future opportunities. Believing the grass is greener on the other side of the fence impels them to hit when they should stick. Instead of acting on what they know is true, people change their course of action to what they want to be true. Change for the sake of change can be damaging and detrimental to progress by realigning the collective learning curve and may be inconsistent with the overall strategy and not congruent with organizational values. Knee jerk reactions occur by acting reflexively rather than thinking reflectively. Effective decision-makers persist and demonstrate patience when faced with unfamiliar stressors that distort reality.
The other side of the coin is the Sunk Costs Fallacy, which occurs when we tell ourselves we shouldn’t quit because of all the time or money we’ve spent in the past. As a result, we escalate our commitment. However, it’s a bad idea to continue to invest resources when we’re in a losing course of action. Sticking with a decision that has run out of steam prevents us from exploring and benefiting from other options. Sound decision makers know when to consider alternatives that help put an end to throwing good money after bad. The reality of sticking is that by spending every hour and dollar on one thing, we sacrifice a preferable future opportunity to spend that hour and dollar on something else. For every hour, every ounce of effort we spend there cannot be spent here.
My wife, Amy, earned an MBA from the University of North Carolina – Chapel Hill, and one of her professors, Dick Levin, wrote a book: Buy Low. Sell High. Collect Early & Pay Late. Great title. I read it. Interesting concepts, but the author disregards the human component of decision-making. We have two primary behavioral drivers — the need for change and the need for stability. Impulsiveness occurs when we irrationally choose to satisfy either need prematurely. Our cognitive biases, distortions, and irrational thinking habits show up when we hit when we should stick or stick when we should hit. Thinking probabilistically strengthens our judgment, but our decision-making processes are primarily contingent upon the perceived values of gains and costs of losses rather than the likelihood of each outcome. We draw the correct conclusion from collecting, organizing, and analyzing data from a problem that stands in the way of our goal. Rather than acting on assumptions and biases, we discover facts emerging from trends, relationships, and the unanticipated factors contributing to the problem that help us decide whether we should hit or stick.
I’m waiting for financial professionals to figure out a way to account for the opportunity costs and hidden costs that irrational belief systems create. Until then, I can only offer a mechanism to avoid those costs.