Overview – Beware the Dangers of Analysis Paralysis
Other than investing, when was the last time you needed to make a decision which needed to be supported by a given set of data and/or had to be compared with other options?
Such a decision can be as major as selecting which university to attend, or even something as trivial as deciding which item to select on a takeout menu.
When it comes to making decisions like these, the procedure most people follow is to first analyze the relevant data, weigh different options given the data they have just analyzed, and then finally make a decision. However, it’s not unheard of for people to be overwhelmed with their vast array of choices and end up making a poor decision or no decision at all.
The inability to decide because of the overwhelming number of factors to consider has a name: analysis paralysis. Because investors are tasked with making all kinds of important decisions, it’s possible to find themselves falling victim to this phenomenon as well.
What is “Analysis Paralysis”?
Put simply, analysis paralysis is when an individual or institution attempts to make a decision but ends up overanalyzing the data and/or overthinking the problem at hand, preventing them from forming a decision. Those who fall victim to analysis paralysis may struggle to decide because they fear that their decision may lead to even more problems, or that the decision they make has to be perfect.
For example, imagine you are given the task of ordering dinner for your family. You’re told that you can decide which place to order from and what food to order.
After being inundated with a wide variety of different choices and things to consider, a flurry of questions and hypothetical scenarios start to appear in your head.
“What if my family doesn’t like this?”, “What if my siblings like the main dish but my parents don’t?”, “If there’s no delivery option, will I be able to pick up the food on time?”: As more questions and hypothetical scenarios start to appear in your mind, it becomes increasingly harder to make a decision.
At best, analysis paralysis can greatly prolong decision-making, at worst, no decision is made at all even if one is required.
Because of the nature of what they do, investors are one of the groups who can fall victim to this.
Now, this isn’t to say that having a lot of options to choose from is a bad thing: investors need adequate variety to ensure they make the best choice possible. Instead, this is a possibility investors must keep in mind when making decisions that involve several variables.
Analysis Paralysis & Investing
Investors make all sorts of decisions, both large and small, regularly. These decisions can range anywhere from deciding which sections of the news to read all the way to deciding which industry or company to analyze next.
Because we live in the Information Age, we are constantly being flooded with data, statistics, and other things to assess. Some of this information is useful, but some of it is utter garbage – the onus rests on investors to filter out the good from the bad.
The argument can even be made that all the work investors do, such as personal study, going over annual reports, and performing investment analysis, ultimately leads to a decision (or decisions) that needs to be made.
Of course, not all decisions are equal – some require only a modicum of thought, whereas others may require lots of discussion and evaluation before a decision can be reached. Some decisions can be made right away, while some may take weeks to decide.
Decision-making is the backbone of investing, so knowing how to make effective decisions is yet another skill investors will need to master if they want to succeed in their careers. Failure to decide when a decision is needed can prove to be very costly.
Now that we know what analysis paralysis is and how it can adversely impact investors, what can they do to avoid it?
Every investor has their limits, meaning they’re all prone to being overwhelmed by the data and choices presented to them, just to different extents. Fortunately, there are some practical ways for investors to minimize the likelihood of this happening. Let’s go over a few.
Some Practical Ways to Avoid Analysis Paralysis
Establish Clearly Defined Parameters/Boundaries
Whenever you’ve made decisions in the past, have you noticed that reaching a decision becomes much easier when there are clearly defined parameters/boundaries to adhere to?
Failure to establish any sort of limits means there are, theoretically speaking, infinite possibilities to choose from. Obviously, no one has the time, energy, or capacity to evaluate every possible choice – attempting to do so can quickly result in analysis paralysis.
By imposing well-defined boundaries, you greatly narrow down the list of possibilities you need to evaluate, and as a result, can focus your time and energy on just a handful of possibilities. Evaluating five options is much easier than trying to evaluate hundreds.
Earlier, we brought up the example of ordering dinner for your family. Despite the freedom to choose where and what to order, this can quickly overwhelm you because this means you have a seemingly infinite number of options to choose from.
If you restrict your search to Japanese food and further restrict it to sushi, then you’ve just eliminated hundreds of other options that you might have previously considered. You could restrict it even further by imposing a budget, say $100, and searching only for restaurants within 15 km of your home.
Say you’re looking to make investments in the oil and gas industry but don’t know where to start. To help narrow your search and avoid analysis paralysis, you can impose certain conditions such as focusing solely on one country and looking for companies that operate in certain parts of the industry (e.g., focusing only on oil and gas companies that have midstream operations).
Evaluating every possibility is akin to trying to boil the ocean – it’s virtually impossible to do and will end up being a massive waste of time. You don’t need to assess every possibility, just the ones that satisfy the criteria you have imposed.
Understand Exactly What Goals Your Decisions Are Trying to Achieve
So many people can easily forget that the purpose of a decision is to help them advance a goal or higher purpose. If you have a clear understanding of what exactly you’re trying to achieve by making a decision, then the decision-making process becomes a lot simpler.
When ordering food, your goal is ultimately to satiate your hunger. Deciding where to order, what to order, and how much you plan to spend should all lead to satisfying your goal of no longer being hungry.
Goals, when paired with clear parameters, can help narrow down your decisions significantly. By pairing the two, you can reduce the number of possibilities you need to assess because you know exactly what you’re trying to achieve and have clear limits to stay within.
Whether they know it or not, every decision an investor makes is influenced by some sort of higher objective. An investor who loses sight of that objective can quickly find themselves being overwhelmed with countless options.
No investment decision (or, at least, very few) is made on a whim – every decision serves the purpose of helping advance an investor’s goals. Keeping them in mind can help remind investors that the decisions they make must ultimately work towards reaching those goals.
Accept the Reality That no Decision is “Perfect”
Analysis paralysis is more than just the inability to decide because of too much data or too many options to evaluate: it’s also what happens when someone is too hung up on trying to make the “perfect” decision.
When making decisions, some people adamantly refuse to settle for anything less than perfect – unless a decision has no flaws at all, then no decision will be made. As all of us know, we all live in an imperfect world.
This isn’t to say that investors can be complacent with their decision-making. Rather, it’s to keep expectations in check of what sorts of decisions investors can realistically make.
An excellent decision isn’t necessarily one that has no drawbacks, nor is it the one with the least drawbacks. An excellent decision offers the most favourable outcomes while also offering the most tolerable drawbacks. There’s a big difference between a decision that maximizes strengths and one that minimizes drawbacks.
Wrapping Up
Making a decision usually involves looking at certain data and weighing other options before making a final choice. While most people have no problem carrying this out, sometimes the data to assess, the choices to compare, and the ramifications of a decision prove too much to handle, leading to analysis paralysis.
Because investors make all kinds of decisions, both big and small, they are also prone to this phenomenon. The inability to make a decision, especially in situations where one is required, can prove to be very costly in more ways than one.
While analysis paralysis has the potential to affect any investor, there are practical ways to help minimize the likelihood of falling victim to it. Regardless of which method an investor chooses, what matters is that they can make informed, effective decisions without feeling overwhelmed.
