Irrational Thinking and Clueless Portfolio Management

PPM Decision Making… Our Challenge!

Perhaps you’ve seen it before.  You are sitting in a portfolio review meeting, everybody is serious and then the charts start appearing.  At first there is not a sound. Everyone is studying what the bubbles indicate.  Then, as each person catches on, eyes start shifting back and forth at each other.

x-ray_IrratThinkingArticle           vs.        Homer_xray_IrratThinkingArticle

Perfectly Rational Decisions Normal Human Choices

A few murmurs are heard as the thought waves get sent out. “Does the VP at the head of the table really believe these numbers?”  “What was the project team smoking when they offered up that revenue amount?”  “Oh cripey, here we go again!” So who makes up these numbers?  Where do they come from? And, more importantly, is the management team actually supposed to make decisions based on what’s being presented?  The disconnect is pretty straightforward.

We have irrational numbers feeding irrational decision making!

Among the organizations I interact with I find the shared challenge of trying to manage their portfolios with poor data quality and a recognition that actions are needed to improve data quality.  However, again and again portfolio managers express that it is difficult to ask a project manager or a project team to go back and change valuations and risk numbers that outsiders may find questionable.  While we know that good portfolio management decisions require good numbers and analytical support, should the portfolio manager actually be the person that questions the numbers?   The answer is flat out “yes!”  But first let’s get an understanding of why these numbers ended up like they did. To do this we need to dive into the topic of microeconomics.  That’s right, that esoteric and heavily theoretical college course some of us took on the way to getting MBA’s and business degrees.

The Pull of Two Branches of Microeconomics

There are two branches of microeconomics that pull at each other in the quest to make economic sense of things.  One branch supports the rational, analytical thinking, the other supports behavioral (psychology-influenced) thinking.  While there is much debate between the two branches as to which is more correct in interpreting the world of economic decisions, both clearly have demonstrated meaningful contributions. On the rational, analytic side we see such foundational building blocks such as supply vs. demand, comparative net present values and efficient frontiers.  Basically, the rational side says “show me the numbers and then I will decide the best course forward.” The behavioral side is a bit different. It turns out that when things look too complex or uncertain our inner Homer Simpson can take over.  A quick scan of these behavioral influences (see Figure 1) gives a purview of the psychological minefield. The behavioral economist argue that humans have developed these behaviors specifically to deal with complexity and uncertainty.  Without these behaviors we’d be dead in the water in trying to make decisions.

Figure 1: Microeconomic Behaviors Influencing Rational Analytics

Figure 1: Microeconomic Behaviors Influencing Rational Analytics

For NPD portfolio management, this stuff maters.  There is no doubt that we should be striving to move from irrational to rational decision making.  The good news is that the negative effect of behavioral (irrational) economics on good decision making goes away as organizations build experience with the relevant decision types and with the taming of complexity and uncertainty.  In other words, experience and accumulated knowledge moves decision makers toward rational decision making and away from behaviorally influenced decision making. Figure 2 tells it all.


Figure 2: Advancing from Irrational to Rational

Figure 1: Advancing from Irrational to Rational


Advancing from Irrational to Rational

The journey from irrational to rational decision making needs to be led by those responsible for NPD portfolio management. Enabling this effort requires both people and tools. While software systems, such as The Adept Group’s Portview™, are important tools for driving data quality and facilitating effective analysis, equally important is the experience and knowledge of those using the data to make the decisions. First off, those leading the effort need to be fluent in both the rational analytics and the irrational behavior side of portfolio decisions, but then it is also critical that they get the experience and knowledge transferred to the decision makers.  The economic value of moving from irrational to rational decision making can then be quite large.

Call to Action

If you are not afraid to get your hands dirty in the muck of portfolio data, you will see that you and your organization can move from the Homer Simpson approach to the Rational Thinking approach to portfolio management.  But first, you just need to understand what you’re dealing with and how to lead your organization in the transition. The objective of The Adept Group Workshop on Portfolio, Pipeline and Platform Management is just that – to give you the insight and tools to assess your current capabilities and make the necessary process, system and cultural improvement.

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  1. […] Paul. 2014. Irrational Thinking and Clueless Portfolio Management. Adept Group. June 2, […]

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