What should you eat for breakfast? What will you wear today? These are just some of the many questions you ask yourself on a daily basis. From the moment you wake up in the morning, your brain is processing millions of pieces of information, helping you make over 35,000 conscious choices every day.
With so many decisions to make, you’d think we would all be expert decision makers. But we’re only human and we sometimes make choices that don’t end well –– whether you choose to snooze your alarm clock and are late to work or you decide to invest in a risky stock that goes bad, one bad choice could mean disaster for you and your wallet.
Luckily, there are techniques and models you can use to make better, more strategic choices. These models, called decision-making frameworks, are designed to guide you through the decision-making process and make a more informed choice when confronted with a problem. They’ll also help you avoid decision biases like cognition bias and the sunk cost fallacy.
3 Decision Making Models for Your Finances
According to Harvard, “decision science is the collection of quantitative techniques used to inform decision-making at the individual and population levels.” Just like a chess master contemplates his every move, masters of decision science are able to choose an optimal solution from many alternatives and can foresee possible results long before they happen.
Before you can apply decision science to your personal, emotional, or even financial dilemmas, you’ll need to understand the basic decision-making frameworks.
1. Rational Decision-Making Model
If you need to make a choice that affects your financial wellbeing, the rational decision-making model could be the best technique. It provides room for thorough research, analysis of alternatives, and can help you manage external factors more easily.
Consider this example. Your family is growing and you’re running out of space in your current home. You’re going to need to find a new place.
- Define the problem: You’re out of space in your current home.
- Establish criteria: You’re on a budget, but proximity to work is also important.
- Weigh criterion: Staying in budget is more important than proximity to work.
- Identify possible solutions: You look at several homes that meet your requirements.
- Choose a solution: You select a house that is less expensive than others.
- Take action: You put an offer down on the home and are approved.
- Review the outcome: You crunch the numbers and are still within budget after buying the home.
Rational decision-making is one of the best frameworks for making major decisions that affect your financial status. If a decision has high stakes or is complex, use this model to make the most informed choice.
2. Bounded Rationality Decision-Making Model
While the rational decision-making model seeks out the optimal solution, it does not account for time constraints or limited information. If you’re up against a deadline or can’t access every piece of information needed, the bounded rationality model –– also known as satisficing –– could be for you.
This model aims to satisfy a problem, not solve it completely. While the steps may look the same as the rational decision model, the bounded rationality model assumes you’re also working with limited resources or time.
Consider the home-buying example mentioned above. Suppose you’re renting your current home and need to find a new place to live before the end of the month. This time constraint would likely affect your decision-making process, as you’ll now need to factor in things like availability of home tours, sellers’ timelines, and the timing of the mortgage process. You may not get the perfect new home for your family, but you’ll get one that satisfies your needs within the constraints.
3. Vroom-Yetton Decision-Making Model
The rational and bounded rationality models both require a good deal of structure in the decision-making process. However, life isn’t always so clear. If you’re not sure where to begin or which decision-making framework to use, try the Vroom-Yetton decision-making model. It’s the decision-making model for decision-making models! It’s also the best option to use if your decision affects more than one person, like a work team or your family.
This model starts with a series of yes-or-no questions that will help you choose the best model for your unique situation. Your answers to these questions ultimately guide you towards the best decision-making process for you –– it could lead you to the bounded rationality model, the rational model, or another one entirely.
Consider this example. Suppose you just learned that you’ve inherited a large sum of money from a distant relative. While you think you should splurge and take your family on a tropical vacation, your partner thinks it would be best to invest the money. In a situation where agreement is important, the Vroom-Yetton decision-making model can help you move towards a solution.
How to Use Decision-Making Frameworks in Personal Finance
Use the visual below to help you make the best choices for your financial wellbeing. Whether you’re hoping to buy a new house or just want to make better spending decisions, these frameworks will give you the tools and strategy you need to make informed choices.
Have a big decision to make that affects your financial wellbeing? Saving money is always important, so be sure to stick to a budget and find creative ways to stay frugal whenever possible!