I generally reach for structured decision-making tools whenever I’m overwhelmed by the decisions I need to make. This could either stem from the importance of the decision or the number of them I need to make at any given moment. The structured approach helps me externalize the decision and keeps it from bouncing around my mind, which just causes anxiety.
This week, I want to focus on what to do when we have many decisions to make at once.
So far, we’ve only seen tactics that focused on a single decision at a time. That may be the case for the most important decisions an executive must make, but generally, decisions are made within a context that includes other decisions.
When looking at multiple decisions together, the problem transforms from “Should the organization invest in this project?” to “Which projects should the organization invest in?” These projects will constitute the organization’s portfolio of investments. Conveniently, portfolio optimization techniques and vocabulary used in the world of finance can also apply to business management matters.
➰Portfolio A set of investments to which a person or an organization allocates their resources in exchange for hopefully greater future returns.
I have split this topic into two parts. This week, we’ll see the general advice applicable to portfolio construction. Next week we’ll explore how this applies specifically to project prioritization.
Here’s my proposed process for building your portfolio that considers multiple investments:
List investments.
Eliminate the obvious bad choices.
Run the remaining ones through a First Decision Loop.
Assess the risk of each investment both individually and collectively.
(Optional) Run a select few investments through a Second Loop.
Pick the elements of your portfolio.
Let’s go through these in order.
Step 1: List Investments Under Consideration
You first need to gather all the investments you want to consider for your portfolio. For each of them, you want to capture:
A name
A description precise enough that someone else could understand the gist of what the investment entails
A measure of success (i.e., what you expect in return for your investment).
Especially if you want to delegate the first examination of the investments, you’ll need to be clear about what each entails and how you will assess their impact. Establishing a shared understanding of what decisions need to be made is essential for this process to succeed.
Step 2: Eliminate the Obvious Bad Choices
Depending on your situation, you may be faced with a large number of alternatives from the start. In that case, your first order of business will be to whittle this down to a manageable amount. The first to go should be the subpar options. Alternatively, you can drop investments that wouldn’t be a good fit for you at this time for reasons other than their potential return.
As a general rule, try to reduce the list to no more than twice the number of projects you likely can invest in. If that helps you be more decisive, keep the ones you cut nearby for you to go back to in case the short list turns out to be lacking. However, in my experience, this has never been needed.
Step 3: Run the Investments Through a First Decision Loop
The rest of the process is iterative. Using the methods of the First Loop from my previous article, you want to get a rough idea of the potential return and risks for each investment.
As a reminder of how to apply the First Loop, for each investment, you (or the people you delegate this task to) want to capture:
An estimate of the impact or return
An estimate of the cost needed to achieve that impact.
These should suffice for a first assessment. However, if coming up with good estimates proves challenging, you can decompose the problem further.
Use Scenarios to Help Produce Accurate Estimates
While I encourage you to keep this first iteration as simple as possible, if estimating certain investments proves difficult, you can break them down further into mutually exclusive scenarios.
For example, if you are trying to estimate the impact, represented by the return on investment, of the R&D of a new technology:
Decompose the problem into two scenarios: one where the technology is successful and one where it isn’t.
For each scenario, estimate its likelihood of happening. Make sure that your estimates sum to 100%.
Calculate the aggregated estimates of impact and cost by computing their weighted average across each scenario.
So, in the R&D example, let’s assume that the new technology succeeds 30% of the time, which would result in a $100 million return. At the same time, it carries a 70% chance of failure, in which case the investment is lost and no return is generated. You can then aggregate the potential impact of the investment by calculating the weighted average cost:
Overall impact = (30% × $100 million) + (70% × $0) = $30 million.
Since the impact can be measured by more than just its return, the different units of measurement might make it difficult to compare between investments. In that case, you can make conversions by constructing a map of indifference. As a reminder, it is a tool that enables comparisons using the answer to the question, “how much of one dimension would you sacrifice for an instant gain in the other dimension?”
To conclude with the example, you can employ the same process of decomposition for estimating the cost of the new technology.
Step 4: Assess the Risk of the Investments
Now that you’ve generated a risk profile for each investment, you should have a better idea of what you are working with. In this step, you analyze the risk profile of each investment to make sure it is aligned with your portfolio strategy.
First, look for investments that share the same risks. These investments have correlated risks, meaning that if something were to go wrong, they will all be affected at the same time*.*
➰Correlated Risks Risks that depend on a common uncertainty. This can lead to good or bad outcomes to happen simultaneously, resulting in bigger shocks in the portfolio.
You want to construct a portfolio that has uncorrelated risks for the same reason you want a diversified portfolio of financial investments: to avoid instances where everything could go wrong at once, putting you in a dire situation.
Problems arise when people fail to notice the ticking time bomb that correlated risks represent, leaving them with only a reactive approach once things go sideways. Despite this, if you decide to have correlated risks in your portfolio, your awareness of it can help you monitor and potentially limit the downsides if events don’t go your way.
You should also watch out for investments that do not match your organization’s risk tolerance. It’s important to avoid bets that the organization is not in a position to make. That said, if some opportunities seem very appealing, despite the associated risks, it may be worth brainstorming risk mitigation strategies that would push the risk profile closer to one that the organization is comfortable with.
(Optional) Step 5: Consider a Second Loop
If you are dealing with larger investments, or struggle to choose between a few options close to the cut line, you may consider gathering more information by doing a Second Loop. We’ll see how to do so in a later article, but for now, suffice to say that you can trade some resources (mostly your time) to get higher precision on your estimates.
This increased precision proves useful only insofar as it can lead to a different (and likely better) decision. If you can’t imagine how reducing the uncertainty would affect your choice, then further refinement of your estimate is a waste of time.
Step 6: Pick the Elements of Your Portfolio
At this point, you should have all the information needed to build your portfolio. This is also the step where you can incorporate other considerations for choosing the elements of your portfolio.
For example, you may want to bias your choices toward sustainable investments or make sure that you have the required people needed to work on the projects you’ve selected.
Return on investment can prove a potent metric, but you should rarely use it as the only one that shapes your portfolio strategy.
When considering other features of the investments, maps of indifference can help guide your decisions. Other times, you’ll have to fall back on your innate preferences or instincts. The trick is to know when each is appropriate.
Thanks for reading this week’s edition of Effective Decisions! I’d love feedback on the content so far and read about ways I could make those articles more helpful to you. Please leave a comment or DM me your suggestions!
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