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Category: Finance

THE DUNNING-KRUGER EFFECT ON BUSINESS DECISIONS: WHAT YOU DON’T KNOW (OR THINK YOU ACTUALLY KNOW) WILL HURT YOU

 

An issue I often encounter with prospective business clients is that they have made a decision/choice, which appeared to be insignificant from their perspective at the time, but it actually was not.   Instead, this decision or action is the catalyst that led to significant legal issues, loss of business revenue, and disputes with other parties.   What started out from their perspective as a minor matter evolved into their business facing significant financial losses, litigation, legal fees and costs, and even the potential closure of their business.

When I inquire of these individuals concerning the linchpin decision/choice that led to this outcome, they have a difficult time explaining their decision or understanding why it led to the legal issues that occurred.  When faced with the decision/choice, they have often said to themselves words to the effect of “no, I’ve got this . . .” or state “really, how difficult can this be.”   Oftentimes, they have taken self-help steps to answer their question (or confirm their decision), but they actually have located incomplete or incorrect information.   Consequently, problems develop.

“How does a company, its leadership, and ownership not see these landmines and issues before they occur?” has often been a question I have asked.   While researching another issue, I came across a research study that may explain this mental roadblock.   It is called the Dunning-Kruger Effect.

The Dunning-Kruger Effect is named after two psychologists who chose to examine why individuals make obviously bad decisions believing they are correct.   Their initial question originated as a result of a news article of a local man who decided to rob a bank.   Having learned that lemon juice can be used as an invisible ink, the robber smeared his face with the substance believing that it would make his facial features unrecognizable or invisible.   Because of this assumption, he made no effort to disguise his face beyond the lemon juice and was quickly caught by law enforcement.   The robber expressed sincere surprise and a complete lack of understanding as to why his plan did not work.

Dunning-Kruger decided to research why individuals make obviously bad decisions, but are completely unaware that they are doing so.   They concluded that individuals who are unskilled, not fully educated, or ignorant of certain matters often suffer from an illusion of superiority believing that their abilities are much greater than in reality.  In basic terms, a little bit of knowledge can be bad because individuals have the tendency (with a little bit of information) to extrapolate that they have more knowledge than they actually possess and, as a result, make bad decisions of which they are completely unaware with disastrous results.

Dunning-Kruger proposed that, for a certain skill or knowledge set, “incompetent” people will:

  1. Fail to recognize their own lack of knowledge or skill;
  2. Fail to recognize the extent of their inadequacy;
  3. Fail to recognize the genuine knowledge or skill in others;
  4. Only recognize and acknowledge their own lack of knowledge or skill when educated otherwise.

This is often the perspective that business leadership and ownership will display.   Business leaders, corporate owners and entrepreneurs have a sense of independence, which sometimes serves them well.   However, this independent streak can lead to an overconfidence in areas where they lack the appropriate skills or knowledge to make an informed decision.   This overconfidence leads to decisions and directions that should have never been taken.

In addition, this overconfidence and lack of complete or accurate information results in their failure to take the advice of others, such as legal counsel, who would be able to properly inform them of their situation and provide advice to avoid the problem.  Instead, the “I’ve got this” or “why should we pay for an attorney for advice when we already know our answer” attitude occurs.    Unfortunately, these businesses only realize their own lack of knowledge after the fact, when a problem has occurred, damage is already done, and they are embroiled in serious legal issues.

In order to prevent the Dunning-Krueger Effect from taking hold of a company’s decision process, businesspeople need to have a team of trusted individuals in place in order to keep them properly educated and informed.   Finding these key individuals, whose only purpose is to help you succeed, are essential for the long-term success of a business.   From my observations and experience, I would recommend four key individuals to become part of the success of your business.   They are:

  1. A Business Attorney or Law Firm
  2. A Business Accountant
  3. A Financial Planner with Business Clients
  4. An Experienced Mentor or Business Coach

Locating and utilizing these individuals who are able to provide answers, advice, and assistance with knowledge, practical experience, and different perspectives will help avoid bad decisions caused by lack of knowledge and overconfidence.    These are also individuals whose purpose is to help a business succeed and have no ulterior motives to the contrary.

Those who own and lead businesses need to accept that they do not know everything.   A quote by philosopher Bertrand Russell highlights this approach.  “One of the painful things about our time is that those who feel certainty are stupid and those with any imagination and understanding are filled with doubt and indecision.”  Every successful business owner/leader acknowledges that they are not omniscient and that they need to utilize the wisdom of others to supply critical knowledge and advice.   Understanding the areas where a business owner or leader has a genuine lack of knowledge or skill and has in place those who can provide this knowledge and skill with which they lack, can lead to a more successful and sustainable business.

©2016 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved

This website has been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.

Book Review: The Go Getter—It Shall Be Done

Go Getter-page-001

Often times business owners will recommend books to their new employees and office staff.   One book repeatedly recommended is a classic: The Go Getter by Peter B. Kyne. I have noticed that this book is also recommended by nationally-known business and success coaches to entry-level executives and sales staff.  In fact, several newer publications of the book include a preface written by one nationally-known and successful individual or another.   These books also contain a modern or more-detailed explanation than what is found in the original book. What makes this book (and the modern variations that have appeared since) popular today?   I believe this popularity is based on the motto of one of the primary characters – “It shall be done.”

The Go Getter was first published in 1921.   Its author, Peter B. Kyne (1880-1957), is unique among business success authors because all indications suggest that he did not set out to write a book about business or success.   Mr. Kyne was an author of short stories and movie screenplays, often set in the San Francisco Bay Area.   The Go Getter is no different and contains a character, Capt. Cappy Ricks, who appears in other Kyne stories of the same period.   The character who sets this book apart from Mr. Kyne’s other short stories is a young World War I veteran, William E. Peck.

The story opens with Cappy Ricks, an older, highly successful California lumberman, complaining about the lack of initiative and integrity among certain of his employees.   At this moment, William Peck enters the office of Cappy Ricks. William Peck is seeking employment and though he has been already been rejected by several other businesses and by Cappy Ricks’ own staff as well. Mr. Peck is undeterred by these previous rejections, and seeks employment directly from Cappy Ricks.   Mr. Peck’s physical appearance sets him apart from most other potential job hunters.   As a disabled veteran from World War I, he walks with a prominent limp and has lost part of one arm.     Although no positions are currently available, Cappy Ricks is impressed by William Peck’s positive attitude, including his initiative of printing business cards labeling him as an employee of Mr. Ricks before he has been hired. Mr. Ricks decides to take a chance and hire Mr. Peck.

Mr. Peck is then given the most difficult sales assignment—selling skunk spruce lumber. He immediately begins to crisscross the Western United States and quickly sells out of this challenging merchandise.   After his success, Mr. Peck is given better products and assignments, which he also successfully sells without neither problem nor complaint.

As the story continues, an important job opening becomes available in the company’s Shanghai office. The main candidate for the position is William Peck.   However, before Cappy Ricks will feel confident about extending the job offer to Mr. Peck, there is one last challenge for the young veteran.   Mr. Peck must complete the purchase of a specific blue vase and deliver it to Cappy Ricks before he leaves town that evening. The vase is to be given as a present for a friend at Mr. Ricks’ travel destination.

This “simple” assignment becomes far more complicated than Cappy Ricks originally suggested.   A good portion of the remainder of the story follows William Peck as he overcomes multiple, roadblocks, misinformation, both time and monetary constraints, as well as uncooperative individuals in order to both procure the vase and transport it to Cappy Ricks before his scheduled event since he missed the original delivery deadline. This assignment culminates with William Peck providing the only item of great monetary value he possessed as collateral in order to purchase the vase and then recruiting a pilot friend to fly him to a location where he could intercept a train to deliver the desired vase directly to Cappy Ricks.

Ricks is surprised and delighted to have the desired vase presented to him by William Peck on his train in the middle of the night.   The surprise stems from the knowledge that Ricks deliberately designed an assignment that was impossible to complete. In fact, Cappy Ricks had utilized this test to assess potential candidates for years, including the current executives in his company, with no one actually succeeding. Often times, the candidates would become frustrated and would quit once the first roadblocks were encountered. Some had resorted to breaking into the shop to illegally acquire the vase. William Peck was the only person who, with a positive attitude and perseverance, accomplished the task.

When asked by Cappy Ricks how he developed his “go-getter” attitude, Mr. Peck relayed the story of his experiences after he received severe injuries during the war. While in bed, wounded, suffering from his multiple injuries, and wondering whether it was worthwhile to go on, he was reminded by his commander of his brigade’s motto “It Shall Be Done.” No matter how difficult the task or roadblocks placed before him, having the attitude of “It shall be done” always allowed him to find a way to overcome whatever challenge was placed before him.

Oftentimes people will become discouraged as they encounter roadblocks along their way. They quit trying and then provide varying excuses which blame forces allegedly outside their control for their failure.   Those who are successful know that multiple roadblocks and setbacks will occur in anything worthwhile to pursue.   Instead of quitting, these individuals move forward, overcome obstacles, look at a failure as a learning opportunity, adapt, evolve, and to find a way to succeed.   These individuals are the real life “go-getters.”

 

©2015 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved

This website has been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.

 

Book Review: Extraordinary Popular Delusions and The Madness of Crowds—Avoid Following the Herd

 

In the 2011 film Salmon Fishing in the Yemen, a life-changing decision by the character, Dr. Alfred Jones, is symbolized when he turns himself around and walks against the current of a crowd that is all traveling the same direction on a sidewalk. Often success in business comes from avoiding the follies of the group and independently developing a different plan. The first and still considered one of the best, books on this subject is Extraordinary Popular Delusions and The Madness of Crowds by Charles Mackay. Its principles and examples of group behavior are just as important today as they were when they were first published in 1841.

The author, Charles Mackay (1812-1889), was a Scottish journalist and author.   While a journalist, he researched and compiled the accounts that form the basis of the two volumes known as Extraordinary Popular Delusions and The Madness of Crowds. Unlike the popular sensational journalism of the time, Mackay provided several heavily-researched and detailed historical anecdotes of the pitfalls of group behavior. His examples of the problems that occur with group behavior have been used by modern social psychologists and economists to describe the dysfunctions of following “the crowd.” It is also often cited by analysts to explain the boom to bust behavior that perpetuates in stock markets.

A general theme found in Mackay’s book is that humans have the tendency to develop a herd mentality. The individuals in the herd then act and react to one stimulus after another in similar and predictable ways.  Mackay theorized when the herd develops “a madness” it can lead to a downward spiral of behaviors that often have very negative consequences. In addition, once this madness occurs it is usually takes individuals, with great difficulty, to break with the norm in order to stop the behavior.

Mackay narrates several historical events to illustrate the negative (and sometimes bizarre) effects that can arise out of a group mentality. These events include the Mississippi Company bubble, the Witch Mania (It wasn’t just in Salem, Massachusetts.), and the South Sea Company bubble as examples of when a group of seemingly rational individuals developed irrational thoughts and behaviors that led to very negative consequences.

The often-cited example in Extraordinary Popular Delusions and The Madness of Crowds is the Tulip Mania, which arose in Europe in the 1600s. The tulip, a simple flower, with its origins in Constantinople, was at first a novelty item for the very wealthy in Europe. Tulip bulbs then evolved from novelty item to status symbol for the upper and middle classes where they became the concentration of serious financial speculation. As the mania amplified, tulip bulbs began being purchased by investors and merchants who utilized most (if not all) of their assets. Producers sold the bulbs for property, gold, and monetary amounts that still seem exorbitant by today’s standards. This pattern of “madness” devolved into wild speculation and hoarding which tainted the region’s economic markets. As often occurs, the speculation then piloted a downward spiral that depressed markets and negatively affected producers for years.

The power in the message of Extraordinary Popular Delusions and The Madness of Crowds is in its timelessness. These same fits of “madness” can be seen today by simply opening the newspaper.   The modern-day observer need only look as far as Cabbage Patch Doll fever in the 1980’s, the Beanie Baby craze of the 1990’s, or the real estate market crash of the last decade as modern-day “tulips.” Other recent examples which appear a few times a year are the crowds of people who camp out for days in order to purchase the newest technological gadget, which can be purchased a couple of weeks (sometimes only days) later by simply walking into the store. Then there are examples of the tensions which dissolve into fights seemingly every Black Friday over a $25 toy at the big-box store, the stock market tech bubble, the successful fraudulent financial schemes orchestrated by Bernie Madoff and similar individuals. The list goes on…

The primary goal as an individual and businessperson is to notice when this herd mentality occurs and to avoid being swept up in the “madness” that can often have disastrous results.  As in Salmon Fishing in the Yemen, going against the current of a crowd will serve your personal and business interests well. Success will often come from avoiding the follies of the group and independently developing a different plan.

© 2014 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved

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This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.

 

The Richest Man in Babylon: Part 2—Seven Cures for a Lean Purse

 

As was outlined in part one of my book review, I am frequently asked about my recommendations for inspirational books for business success and personal finance. My first recommendation is often for a book that was first published over 85 years ago – The Richest Man in Babylon by George S. Clason. You can read part one of my book review here.

The Richest Man in Babylon by George S. Clayson

Clason utilizes the background of the Kingdom of Babylon as the setting for the story to introduce several fictional characters (from both ancient and modern times) to explain the principals of money, responsibility, and personal finance. One of these characters is Arkad. Arkad’s journey is a “rags to riches” story where he begins life as a slave. Over time, he is able to buy his freedom, and eventually becomes the richest man in Babylon. The king of Babylon requests that Arkad teach what he has learned to a group of citizens. In a group of lectures Arkad introduces Seven Cures for a Lean Purse.

The Seven Cures for a Lean Purse

  1. “Start thy purse to fattening”                                                                                                                                 

The first cure, Start thy purse to fattening, demonstrates the need to recognize that no matter the amount of income you receive, a portion should be set aside for saving. The Richest Man in Babylon emphasizes that everyone should save a least ten percent of their income every month. The act of saving allows you to view money from a different perspective – money is not just for instant gratification or to be used to react to one alleged crisis or another. Instead, money becomes a long term instrument for your benefit.

  1. “Control thy expenditures.”

Under the principle, Control thy expenditures, one learns that the amount of income earned is not important to long-term wealth.   Instead, the importance is to concentrate on how that money is actually spent. A proactive plan and budget for expenses will have the greatest long-term impact on your financial success. We often see examples of this concept on the news in the stories of individuals who win millions of dollars in a lottery, only to have it spent within a few years. Compare this to the story of the person with a low yearly income who lives frugally and is able to retire comfortably and provide a multimillion dollar endowment to a charity. The primary difference between these two examples is the perspectives on how the individuals to spend the money they have—not the amount of money that is available at any one time.

  1. “Make thy gold multiply.”

Saving money does not mean to hide it in a mattress, in mason jars in the back yard, or inside the covers of books in your personal library. Instead, make your savings work for you by developing a reasonable financial plan to allow your money earn a return on investment.   Creating an investment plan that can provide a consistent return over time is essential to make thy gold multiply.

  1. “Guard thy treasures from loss.”                                                                                                                                                     

Cure number four – Guard thy treasures from loss, works in conjunction with the third cure. Success comes from the consistent application of an investment plan over time. It does not come from attempting to chase the newest financial trends or from a salesperson with claims of high rate returns with no risk. Financial success also does not come from following someone who promises a new money-making scheme that no one has ever thought of before.   Instead, these are more often than not ways to lose your treasures (often on a large scale). Concentrating on a consistent well-proven approach will help one avoid these salespeople and truly guard your money.

  1. “Make thy dwelling a profitable investment.”

Looking at the home you live in as an investment is the concept that purchasing a home can assist in long-term wealth accumulation.   There are financial advisors that teach quite the opposite view of real estate, and the financial crisis of the last few years dampened the enthusiasm of purchasing a home. However, the fact remains that once a mortgage is paid, the largest monthly expenditure for a family is usually eliminated and can then be utilized for other purposes. A renter will never be able to achieve this level of monetary freedom.

  1. “Insure a future income.”

An individual needs to look beyond saving and accumulating wealth in the present to the possibility that the ability to accumulate wealth may diminish or end at some point in the future. A retirement plan is essential to prepare for that future date. In addition to a basic retirement plan, contingency plans need to be in place to help insure an income if an unexpected event happens. These future plans should include addressing health, disability, life, and long-term care insurance needs.

  1. “Increase thy ability to earn.”

Frequently, when one reads books or articles written about successful individuals a common thread emerges. No matter the amount of wealth, prestige, or power obtained, successful individuals never lose their desire to learn and better themselves. The desire to better ones self and to accumulate knowledge prevents stagnation, allows an individual to understand new concepts, and become both a better earner and a better investor.

Although The Richest Man in Babylon is approaching 90 years in publication, the principles it teaches are just as important today as they were before the Great Depression.   The longevity of Clason’s book demonstrates that the principles outlined are timeless and have brought financial success to the generations of people who have applied them. In addition, if these principles had been more widely applied by individuals and businesses at the time of first publication, it would have lessened the impact of the Great Depression. Their further utilization would have made the most recent spate of financial troubles less catastrophic as well.

Also, I often think of my paternal grandparents’ philosophy of personal finance. As a young married couple, they lived in and faced the brunt of the Great Depression. Despite personal and financial setbacks, they developed a similar set of financial principles to the “cures for a lean purse.” That fiscal mind set led them to financial security that they were able to maintain throughout their lives.

To read Part One of the book review for The Richest Man in Babylon click here.

© 2014 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved

This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.

The Richest Man in Babylon—a Pioneer Book in Personal Finance

 

As a business/commercial law attorney, I am often asked about my recommendations for inspirational books for business success and personal finance. Often times, people assume this genre of self-improvement books has a history within the last 20-30 years when the subject gained popularity. However, my first recommendation is often for a book that was first published over 85 years ago – The Richest Man in Babylon by George S. Clason. The principles it teaches are just as important today as they were before the Great Depression.The Richest Man in Babylon by George S. Clayson

The author, George S. Clason (1874-1957), was owner of the Clason Map Company and Clason Publishing Company one of the first companies to publish a road atlas of North America.   However, he was better known for publishing a series of pamphlets on thrift and financial success, which first appeared in 1926. These pamphlets became very popular and were bought by insurance companies and banks for distribution to their respective clients/account holders. The Richest Man in Babylon is a compilation of these pamphlets. You will also notice the principles outlined by George Clason are consistently utilized by current financial and self-help authors today.

This book is an examination of how the Kingdom of Babylon was transformed from a small village on the Euphrates River to become one of the wealthiest and most powerful kingdoms in the ancient world. To explain this transformation, Clason introduces several fictional characters (from both ancient and modern times) to explain the principals of money, responsibility, and personal finance. The Richest Man in Babylon highlights that personal wealth and success do not occur overnight– with fast solutions and through get-rich-quick schemes. Instead, wealth accumulates by applying a consistent set of principles over time.   The book introduces both the Seven Cures for a Lean Purse and the Five Laws of Gold. For purposes of this post, I will concentrate on the Five Laws of Gold.

The Five Laws of Gold

  1. “Gold cometh gladly and in increasing quantity to any man who will put no less than one-tenth of his earnings to create an estate for this future and that of his family.”

The first law is to become a saver and make saving a priority in every financial decision. In a world that emphasizes immediate gratification and the “buy now, pay later” mentality, shifting a focus to the initial thought of saving helps eliminate the need for immediate gratification and results.

  1. “Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field.”

 A successful financial plan is developed by finding a process where one can consistently make a positive financial return over time. We need to avoid the extremes between hiding money in a mattress to wild speculation and day trading. Instead we are looking for the consistent return. The baseball example I use is that we want a high batting percentage of singles and the occasional double—not always swinging for the home run.

  1. Gold clingeth to the protection of the cautious owner who invests it under the advice of men in its handling.” No individual can have all the answers.

If we attempt to do it all, our focus and priorities are often watered down in the process. Instead, we must seek men and women around us whom we can trust to provide us sound advice and counsel.

  1. “Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep.”

This principle reminds me of the old saying “Dance with the one that brought you.” Often individuals want to follow the newest trend or fad even though their personal knowledge of this potential opportunity does not exist. Instead, the goal should be to find investments that we (through the course of our everyday work, hobbies, and interactions) have developed a practical experience and knowledge. That experience and knowledge can be utilized to our advantage.

  1. “Gold flees the man who would force it to impossible earnings or who followed the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment.”

There are no quick answers and you cannot become “rich overnight.”   A lot of the financial catastrophes we have observed in the past 20 years (from the tech bubble bursting in the 1990s to the financial meltdown of 2007-2008) are based on the notion of quick results. New schemes are found that, in the long run, do not work and cause more harm than good. We need to avoid the quick decisions based on feelings and personal dreams. Instead, we should focus on a practical empirical approach that takes emotion and popularity out of our financial or business decisions.

I first read The Richest Man in Babylon soon after graduating from law school. As an attorney starting my legal career and first post-degree job, accompanied by typical law school student loan debt, I wondered how I would be able to tackle my new career along and establish myself for future financial success. The down-to-earth examples provided in The Richest Man in Babylon highlighted the fact that obtaining financial success is a marathon and not a sprint. Consistent application of basic financial principles is what leads to success.

To read Part 2 of the review of The Richest Man in Babylon click here.

© 2014 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved

This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.