Many small business owners lack the skills to make good financial business decisions. But it is not always a result of their lack of experience, interest or education in this difficult area.
The Effect of Human Nature on Financial Decision Making
According to John Howe, author of “The Foolish Corner: Avoiding Mind Traps in Personal Financial Decisions”, it involves human nature and the evolutionary instincts that take over inside of every person when faced with these types of choices. He says that the first step in making better financial business decisions is to be aware that there are internal biases that are affecting each outcome.
1. Overconfidence. This is when the small business owner is so sure of the outcome despite market data and feedback telling them otherwise. They do need optimism, but when it mushrooms into blinding overconfidence, they ignore reality and it becomes a problem. This happens many times because they have made a big financial bet where they do not feel they can turn back. Solution: The successful small business owner knows when stop, pivot and move on to a new strategy. A safety switch to insure against overconfidence is to have reliable sounding boards from trustworthy sources. These can’t just be “yes men” that will agree with every financial business decision the owner makes. Rather, they need to be advisors or mentors that can play a devil’s advocate role and are not afraid to disagree on a regular basis.
2. Supercharged emotion. Financial business decisions around money can be emotional. Things like wanting to win at any cost or extracting revenge based on the past can also be factors. Overall, most competitive small business owners hate to lose at anything. This can only end up clouding their judgement. Solution: Base decisions on results from a variety of sources. Ask advisors who are not emotionally involved with a particular decision to give their viewpoint. The small business owner needs to try to name the emotions they are feeling that are not grounded in fact based conclusions.
3. Internal bias. Every owner has a predisposition they bring to any decision making. It helps them frame the problem and then, the solution. In their own mind, this is based on what has worked or not worked in the past. Solution: A small business owner needs to know that their outlook is not always accurate or actually optimal. Again, ask an advisor who is outside the company or the process to give their viewpoint.
4. Peer pressure. For many small business owners, it is more comfortable to follow what others are doing. They make financial decisions based on what is popular or generally accepted since they want to “keep up with the Joneses”. They are afraid if they do not invest when or how others do, they will be single out as a loser when everyone else has success. Solution: Get comfortable in dissenting from what others think. Analyze the decisions to be made with all the pros and cons that are separate from any outside pressure or paths that others have taken before.
It’s a balancing act. Small business owners do need to trust their experience and instinct when making financial business decisions. At the same time, they need to understand what gets in the way of the an optimal outcome.