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AREA Method: What Benjamin Graham Can Teach Us About Decision Making​

As the stock market has been taking a wild ride these past few weeks, I’ve been finishing up a new book, currently titled Investing In Financial Research: A Decision Making System For Better Results. It is scheduled to be published in the fall. It’s an updated general interest version of the textbook I wrote initially for my Columbia Business School students and that I’ve been teaching with for a decade in my Advanced Investment Research class. This new book applies my AREA Method of research and decision making specifically to financial and investment analysis.

I’ve also been re-reading a classic investing book: Benjamin Graham’s The Intelligent Investor, which, back in 1949, first described the philosophy of value investing and discussed how to think about financial goal setting. In his book Graham astutely concludes that how your investments behave is much less important than how you behave. Almost 70 years later, this observation continues to ring true. If you have money in the stock market, how have you behaved recently?

Did you check the news frequently? Call your broker and make a trade? Or did you sit it out? In other words, did you wait or take action? It’s a question many of us wrestle with regularly because after all, to wait is a decision in itself.

Sometimes waiting is as good as –or better– than acting, but when, and how might we know that the inaction is the right decision? In general, inaction is the norm. Newton’s First Law of Thermodynamics states that an object at rest will stay at rest unless acted upon by an outside force. We don’t like to think of ourselves as objects, but human beings do seem to follow Newton’s Law.

One example of how inaction is the norm is how few people get the flu vaccine. Every year, many of us get the flu and about 36,000 Americans die from it. We know there’s a scientifically proven method to reduce our likelihood of getting this illness: we can get a flu shot. Yet the CDC reports that only 45% of Americans get the vaccine –and the numbers are falling. Why? Some of us think we’ll be the lucky ones who avoid the flu, some of us think we don’t have enough — or the optimal – information to make an informed decision, but many of us just don’t get around to getting the vaccine. It’s easier not to get the vaccine than to get it. We make a choice by not making one.

Ironically when it comes to the stock market, many of us panic and sell at the first sign of volatility. We know that the classic investing advice says “wait it out,” patience is required. But our aversion to loss is difficult to ignore. Think again of Newton: An object in motion stays in motion. But we shouldn’t act for the sake of acting. Volatility in the markets says little to nothing about the underlying fundamentals of a company’s intrinsic value, and those fundamentals should reassert themselves over the long term.

Whether we wait or take action, we should be doing it mindfully, with purpose, a plan, and with data.

This issue surfaced in my recent workshop to a group of CEOs in New York City. The CEOs ran companies in healthcare, security, wine exporting and more. They all faced decisions that they were reluctant to act on, even though they knew the decisions needed to be made in the next 12 months.

Why? Their inaction, they said, stemmed from being unsure about how to act. They recognized that what was in short supply was not ideas (see above about the flu shot and long-term investing) but rather how vet and implement the ideas.

I’ve written about the difference between strategy and execution before but in the case of the CEOs, this classic problem had an extra — and familiar — wrinkle: overcoming resistance. The CEOs worried that others would balk at the changes. A few examples of their decisions:

  • Switching warehouse companies
  • Changing compensation plans
  • Shuttering a business line

None of the CEOs had evidence that they would run into resistance. They said they “just knew” they would. The result: The perceived inertia created even more resistance; the CEOs’ own!

To overcome this bottleneck, I took the CEOs through a creative exercise, part of the AREA Method, that asked them as decision makers to test their assumptions against their evidence. They realized that they were guessing at how the information would be received and therefore assessing the outcome as unattractive. They thought they knew how the other stakeholders would react because the CEOS saw themselves as experts about their companies. But they hadn’t actually collected –or tested–the data.

Psychologist Baruch Fischhoff, at Carnegie Mellon University, has documented that people who have an expertise about something, think that they know more than they do. In other words, when we are familiar with a situation or organization, we don’t check our perception with data. That’s why investing in what you know can be so dangerous (think of the employees of troubled Enron or WorldCom who owned vast amounts of their company’s shares, and were left holding worthless paper when wrongdoing was exposed). The more we know about something the less likely we may be to probe it for weaknesses.

This form of overconfidence is called ‘home bias.’ It’s the habit of sticking to what is already familiar. One example: Adding foreign stocks to a portfolio is said to lower the portfolio’s systemic risk by reducing exposure to domestic market changes. Yet investors worldwide tend to be biased toward their own domestic equities.

The past does not need to be prologue. I asked the CEOs to change their perception of reality by updating their facts so that they would not fall prey to old fact patterns and assumptions. They also assessed the cost of doing nothing. For example, while offering online service may cut into a company’s profits, not offering that popular option might render the company irrelevant.

I also tasked them to look from the perspective of their employees. Did they need more data or a different analysis? And could they be transparent in communicating their thought process and research? The audit trail they created — fundamental to the AREA Method — gave them a blueprint that could be a discussion document when presenting their ideas and generating buy-in.

The bottom line: when deciding whether to sit and wait or to take action, remember that neither is productive done for the wrong reasons. Instead, be mindful, act with purpose, with a plan and with good data.


How can AREA help you and your business make big decisions better? Sign up for coaching, workshops or have Cheryl come speak to your organization by emailing Cheryl can customize a workshop for your company, or she offers one-day or three-day in-person workshops and a month long, once a week webinar.

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