Sometimes it’s painful to realize that we’re exactly where we’re supposed to be. Coming to an understanding that your financial life is primarily the result of the entire set of financial decisions you have made so far can be humbling.
There is certainly an effect from the hand we’re dealt; not everyone is born into wealth and ease. But those who are probably aren’t bemoaning their financial circumstances.
For most people in the developed world, our decisions are the greatest determinant of our results. If we want a better financial life, we need to start making better financial decisions.
The problem isn’t that people tend to make “bad” financial decisions. Sometimes it is, but that’s not the norm.
The norm is making suboptimal financial decisions. The norm is doing a bit less than what’s best.
The cumulative effects of somewhat less than very good decisions is a total of less than very good results. There’s good news in that. For most people, making better financial decisions involves a tweak, not an overhaul. Let’s start by looking at where things go wrong.
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The Realm of Suboptimal Decisions
The realm of suboptimal decisions is primarily two-dimensional. Those dimensions are context and emotion. The problem often occurs in not just one, but both. We’ll start by looking at them individually.
Context is a financial decision’s relationship and impact on the rest of your finances. Nothing occurs in a vacuum, When you change one thing, other things change.
For example, if you increase contributions to your 401(k), not only does your future retirement change, but your present cash flow also changes, as does your present tax situation.
Buying a new car with a loan doesn’t only add the loan to your budget. It may also change a variety of other expenses as well, such as insurance, fuel, and maintenance costs.
Emotion drives an awful lot of purchases and most of the regret associated with them. We all have emotions, and it would be a pretty dull world without them. Emotions themselves aren’t the problem.
It’s when we act impulsively due to the power of emotion that we tend to make those suboptimal decisions. There are several things we can do to frame our decisions and deal with the negative effects of lack of context and excess of emotion.
Building Context for Financial Decisions
To understand a financial decision’s impact on the rest of your financial situation, you need to have a good grasp on your financial situation. This means a couple of things.
You need to have a budget. It doesn’t have to be in a particular form, but you need to have a handle on what’s coming in, what’s going out, and what’s left over.
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You also need to have goals.
It’s nearly impossible to see the long-term effects of a financial decision other than in the context of your goals.
Those are what will be affected by the changes you make in the present.
And you need to have values. Well, sort of. Having clarity around your values makes it easier. But you can work with having priorities around your goals.
This is a major piece of information you get from having values, but you can determine priorities independently of values. But when things change in your situation, you need to know if you’re going to let it impact your retirement or your children’s education. Or perhaps something else. But you need to know.
Understanding Your Emotional Landscape
Typically, car salesmen don’t try to wow you with a car’s whistles and bells. Instead, they try to get you emotionally attached to the purchase.
They’ll talk about how you’ll feel pulling into work in the car or some such thing to try to get you emotionally involved in the purchase. They try to do that because it works. Their chances of a nice profitable sale depend on getting you emotionally attached.
So what do you do? How do you beat the system?
I can remember times when I went to the grocery store hungry and came home with bags and bags of groceries but no real food. Plenty of chips and garbage, but nothing to make a meal out of. That taught me not to shop hungry. That removed the emotional attachment to those salty chips from the equation.
Later, I learned to meal plan and shop purposefully. It’s much easier to avoid emotion-driven impulse purchases when you have a plan. For larger purchases, it helps to force time constraints.
Make a deal with yourself that you won’t make any purchase over X amount without at least sleeping on it.
Your X amount can be whatever you choose. It can be $100 or $1,000, but it needs to be reasonable for your situation. It should be low enough that you wouldn’t feel bad blowing the money and it wouldn’t hurt your budget.
Know your weaknesses. Some people get excited about a new car, others not so much. But they have their things. Whether it’s shoes or tools, everyone has their things. You need to be especially vigilant around your particular hot buttons.
The Decision Process
While it’s not a good idea to rush into hasty decisions, procrastination is equally dangerous, as it leads to lost opportunity and suboptimal decisions.
Procrastination tends to be rooted in fear. It may be fear of doing the wrong thing, or it could be another fear. But in most cases, if you’re procrastinating on a decision, there’s something there to look at, some fear that’s getting in the way. And not making a decision is still a decision — it’s just not a conscious one.
Consider using a list of pros and cons. It can be very helpful to put it in writing. This makes the negatives harder to ignore and requires you to justify the positives a little more rigorously.
There are a lot of financial decision-making tools that can help with numeracy and calculations, so you don’t have to be a math whiz. But overanalysis — analysis paralysis — doesn’t help.
If a decision is overly challenging to figure out, you can always seek help, either through a professional or perhaps someone you know. But decisions shouldn’t fester like untreated wounds. Consider the options and make the best choice you can in light of the available information.
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The Bottom Line on Making Better Financial Decisions
If you're making a decision understanding its ramifications on the rest of your financial situation, if the decision is in alignment with your values and priorities, and it’s not an emotional reaction, then that’s the best you can ask for. And if that’s how you make decisions across time, you’ll begin to look at where you are financially and be proud that where you are is the sum total of the financial decisions you have made.
