Many times we are faced with making difficult decisions where we cannot make up our minds on what would be the best course of action. Examples of these situations would include being pirated by another company, filing a lawsuit or accepting a compromise, making an investment, and anything else that involves taking a risk. How do you then determine the best course of action? You need to determine your point of indifference.
The point of indifference is when your outcome is something that does not offer you an advantage or a loss. That being the case you would be better off not proceeding with the offered course of action. As an example, should you leave your job and take the job offer of a competitor? You need to take into account not just the financial implications but many other things like your career prospects, reputation, organizational fit, and personal satisfaction. Many people make the wrong decision by just basing their choice on the immediate higher salary but not realizing that over the long term, the salary increases could be lower and less frequent, a dead end career path and more difficult working conditions.
Filing a lawsuit or accepting a compromise is also very emotionally driven, but being more level headed could save everyone a lot of grief. In these cases, the amount in question may not be the main driving factor but should be tempered by the cost and time of litigation as well as the risk of losing the case. Obviously, if the situation is so onerous that there is little or no downside to one of the parties, it would only be reasonable to expect legal action. However, taking legal action may cost more than the amount that is being contested and take many years to resolve that other alternatives may provide a better option.
When you make an investment, not only should you take into account your net gain but also the risk you take, transaction costs and other considerations. Would you make an investment using borrowed money if the cost of the loan is 10%? It certainly would not make sense to do so if the return on investment only provides a cash yield of 5%, which would not even be enough to pay for the interest on the loan. However, if there is a potential capital gain of 20%, then that would be a different story. Of course you need to take into account the probability or likelihood of such a capital gain and the amount of risk you are willing to take.
Balancing the risk vs return is key in determining the point of indifference. Would you buy a lottery ticket if the only upside you have is just winning back the cost of the ticket? Certainly no one would buy lottery tickets. Notice also how more people buy lotto tickets when the winning number runs into some astronomical figure. People are willing to take on higher risks if the returns are also higher and vice versa. Once you are able to understand and quantify your point of indifference, you will be in a better position to make smarter choices.(The views and comments of the author are his own and not of the newspaper or FINEX. He was 2016 FINEX President, an entrepreneur and also a professorial lecturer at the University of the Philippines, Diliman.Comments may be sent to [email protected]