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One of my driving forces in life is understanding better ways to approach problems: money problems, work problems, society’s problems. How do we best approach these problems to find effective solutions? There are a few mental shortcuts that I use on a regular basis.
Let’s discuss a few different thought experiments and heuristics. I think you’ll find these mental shortcuts useful in your future problem solving.
In its simplest terms, floor-to-ceiling analysis is a mental shortcut that asks you to bound a given scenario with the worst-case (floor) and best-case (ceiling) outcomes. From there, you can identify opportunities to improve the scenario by directly raising that floor and/or ceiling.
- You need a new car. The cost of car ownership is quite high.
- The floor scenario is that the new car you buy is poorly made and needs constant repair, or perhaps that you crash it immediately after buying it.
- The ceiling scenario is that it’s a piece of engineering genius. It never has a big breakdown, and you drive it for 20+ years.
Now, to decrease the pain from the floor scenarios, you’d insure the car (for the crash scenario) and ensure it has a good warranty (for the repairs scenario). An immediate crash would still suck, but insurance has raised that floor significantly. Ideally, you’d want to increase the probability that you reach the ceiling.
So you’d do research (Consumer Reports, Kelley Blue Book , other auto experts) to try to identify the make and model of vehicle that is engineered the best, and likely to last the longest.
On a personal finance note, much of the advice I provide on the Best Interest is about raising the floor. The ceiling of personal finance is, essentially, akin to winning the lottery. It’s a scenario so good that it doesn’t need improving.
But the floor! That’s worth focusing on.
Why is an emergency fund important? Because having no food or no heat in winter is a very painful floor. Why is avoiding debt important? Because the weight of debt over many years is a stressful and straining floor.
One Big Thing (“The Mode”)
I play the sport of squash. No, not the vegetable; it’s an indoor racket sport, similar to racquetball!
Without getting into too many details, an individual squash match involves 50-100 points, each of which consists of anywhere from 5 to 50 individual shots (instances of a player hitting the ball). There’s lots of movement, speed and stamina, and even some trickery!
So, there are a lot of moving parts and variables. To simplify things, I’ve gotten into this little habit: after every point, I ask myself, “What’s the one thing that led to me winning/losing that point?”
Maybe I chose a poor shot to hit. Or maybe I tricked my opponent with an unconventional shot. Maybe I took my eye off the ball. There are many reasons why things go right or wrong!
Then, after the match is over, I have a histogram of reasons in my head, where one reason typically peaks higher than the others. I can say, “I executed shots really well today, but I lost a lot of points because I’m out of shape.”
It’s that simple!
Out of the many, many rights and wrongs, I’ve identified the One Big Thing that I can focus on improving. For you math nerds, you’ll recognize that I’m isolating the mode of my many small reasons, and taking that as my One Big Thing.
It’s a simple mental shortcut to find the most important factor!
In the money world, your One Big Thing might be your net worth target, the time until you can purchase your next real estate investment or the time to build a high-income skill. It’s the one simple metric that you can use to gauge your financial health.
Do you know your One Big Thing?
Store-brand peanut butter or JIF? The JIF costs a dollar more. But it tastes better! What to do?!
I’d give myself about 10 seconds to make this decision. After those 10 seconds, the value of the time I’m spending on the decision will start to approach, and eventually surpass, the value of the decision itself ($1).
Spend your time deciding big ticket items, such as vehicles, housing, consumer electronics. But which shoelaces to buy? Which bananas to purchase? Give yourself a few moments to look at the options, and then pick. Do you know the value of your time?
A simple heuristic for doing research or choosing between items:
- Single-digit $ items—spend seconds. ($3 peanut butter – spend seconds on the decision)
- Double digit $$—spend minutes, up to an hour.
- Triple digit $$$—spend hours, up to a day.
- Thousands $$$$ or more—spend days to weeks.
The more something costs, the more well-spent your time is on the purchasing decision. What an easy mental shortcut!
Granted, lots of people implement a “sit on it” rule when they want to buy something. They know they’re susceptible to stupid purchases. So they let purchases sit in their online shopping cart (or mental shopping cart) for a few days and then re-check.
If they still want the item, they buy it!
The 80/20 Rule
The 80/20 Rule, also known as the Pareto Principle, suggests that 80% of all consequences are caused by 20% of all causes. Examples help explain it more clearly.
- A car company might find that 80% of its cars’ breakdowns are caused by the worse-designed 20% of its components.
- A baseball team might find that 80% of its errors are committed by the 20% worst fielders on the team.
- An investor might find that 80% of his portfolio returns come from her 20% best performing stocks
These patterns exist everywhere. It’s not magic. It’s just statistics! Standard power law distributions will almost always exhibit the Pareto principle. The numbers might change (e.g. 90/10 instead of 80/20), but the idea is there.
In your life, can you identify the biggest causes of your problems and successes?
- Are 80% of your dieting “failures” stemming from 20% of the foods you eat? I know I’m a sucker for chips and crackers. Maybe I’d do better to completely cut them out. New rule!
- Does 80% of your business’s revenue come from the best 20% of your customers? Maybe you should remind them how important they are to you.
- Is 80% of your financial regret caused by a limited number of items that you buy? Do you have $1000s worth of books that you’ll never read, maybe you should give yourself a rule: no more new books!
If you’re looking for ways to improve your life or ways to keep the good times rolling start by identifying the biggest factors. For fun, determine the ergodicity by comparing the time average of a system against the expected value of that system.
You can quickly make a big, positive change if you can find the 20% of inputs that are most impactful.
And you, reader?
There are other really cool mental shortcuts out there, but these are a few that I use frequently. Good mental shortcuts save time and energy, but still maintain quality decision making.
What are some heuristics that you’ve used in your life? You might be surprised. There’s a fairly large list of common ones on Wikipedia, and I’ve accrued a list of 75 rules of thumb specific to personal finance.