Financial decisions are unavoidable. They are there whether we want them to be or not. We must decide where to live, what to eat, what to drive, or even if to drive. Any decision that involves consumption will involve finances; and we are perpetual consumers.
If there were no uncertainty — no unknown variables lurking in the shadows and a perfect predictability to outcomes — we could simply program our decisions to produce financially optimal outcomes.
But it is harder than that. Just because an option is the best financial choice doesn’t mean it’s the best choice. If it were, no one would have more than one or two pairs of shoes.
When economic uncertainty is widespread the decision-making becomes more complex. We need to weight our choices differently than we might in more tranquil times.
Financial decision-making is the process of weighing the financial ramifications of choices to make informed choices.
It is making decisions involving our money from the standpoint of awareness.
What is absent from financial decision-making is adherence to financial optimization or expense minimization. They can be tools to achieve specific goals, generally best suited for short-term use.
To make good financial decisions, we need to actively seek out information. We need to know the consequences of alternative decisions.
Which is not always about the money. Sometimes the decision to buy an overpriced bottle of water is more about avoiding discomfort or dehydration; we may know it’s not financially optimal, but the other considerations outweigh the financial. Financial decisions must be made in context.
Context of Financial Decisions
The scope of the decision matters. This works in two ways.
We tend to know we need to be prudent in our larger decisions. Some people might buy a car on emotion; most of us know that’s not a good way to make a big financial decision.
We know we should consider our needs more than our wants and weigh the pros and cons of alternative choices to consider the long-term costs of ownership. There is a key to this that isn’t always obvious.
It’s not just the cost of the purchase that is making consideration of finances important, it is the cost of the consequences to the decision. We need to consider the long-term costs of both the decision and the alternatives.
For example, a large truck that might appear affordable today could become a poor decision if gas prices rise considerably — especially if we have a long commute. It’s not just the price of the item being evaluated; it is the price of the potential consequences.
Sometimes even smaller financial decisions have potentially larger consequences and bear the scrutiny we might typically reserve for bigger decisions.
Other financial decisions seem insignificant on their own but are important because of their cumulative effects.
That $5-a-day latte is really a $1,250-a-year latte, which makes it the $50,000 career latte. The $5 is itself insignificant. The $50,000, which becomes much more than $50,000 with investment returns, more like over $300,000, is significant.
Decisions need to be considered in context. We need to consider the option of saving versus spending, the opportunity cost of our present luxuries, the effects on our long-term goals. There’s a lot to consider. It is more challenging during uncertain times.
Financial Decisions During Uncertainty
Sometimes financial uncertainty comes from situations external to us, such as the current pandemic or something else completely outside of our control. Other times the uncertainty is due to our own situation: We end up in a situation of job or housing insecurity, for example.
The challenge of uncertainty is that we don’t know what we don’t know. We may not be able to rely on our income continuing or our expenses remaining constant. Loss of income or increase in expenses, and possibly both, can wreak havoc on carefully construed plans.
There are specific techniques we can incorporate into our financial decision-making process to reduce our personal financial risk and help us to weather these storms. Here are four strategies for dealing with financial decisions during uncertainty.
Risk avoidance is imperative in financially uncertain times. Taking on additional expenses, for example, when there is doubt about future paychecks, is certainly not prudent. Not in most cases.
We can mitigate risk by decreasing expenses. This serves two purposes.
When we decrease expenses we lower our needs, preparing us in advance for a potential reduction in income or providing some additional room in the budget if an expense has to go up for reasons outside our control. This can happen if we suddenly need to move or face some other significant upheaval.
Plus, when we decrease our expenses, we have the opportunity to save those funds. This allows us to increase our reserves, which can further help us with any unexpected expenses or reduction in income.
Frugality can look good during uncertain times, it allows us to keep costs down and build reserves in a shorter period of time.
Some bigger decisions may be best postponed. This really depends on the degree of financial insecurity you are experiencing.
Postponing financial decisions that can reasonably be postponed prevents you from assuming additional debts or other obligations that might be hard to maintain should things get worse.
If you feel your income is in jeopardy it might be a good idea to delay major purchases until you regain confidence in your situation.
A new car doesn’t look good in the driveway when there’s no income to pay for it — but not all financial decisions, not even big ones, can be postponed.
A bridge decision is typically not the best decision financially, but postpones the necessity of making a potentially costly decision.
You might, for example, be considering a new car because yours is needing a bit of work. But you don’t want to take on the additional obligation of an auto loan at this point.
You have alternatives. You could bridge the problem in several different ways. Perhaps you spend some money on your current vehicle to get another year or two out of it. Perhaps you buy a used vehicle to get you through the next couple years without having the bigger expense of a new car.
The essence of a bridge decision is that it probably isn’t the best long-term financial decision but it reduces your risk until you are more confident to make the decisions you want to make.
Taking on additional risk might outweigh other factors and lead you to bridging the problem rather than seeking the best long-term solution.
While there is a degree of broad economic uncertainty, it isn’t all doom and gloom. Some people have more uncertainty than others. There are instances in which people can take advantage of the present situation, as long as it is prudent to do so.
Uncertainty creates risk. We reduce risk by planning for the worst-case scenarios. But not everyone’s worst case is the same. Not everyone is facing job insecurity or other major financial insecurity. Some people face less risk and can afford to be cautiously optimistic.
If you are in a position to be cautiously optimistic, you may be able to take advantage of the present situation.
You might, for example, have more negotiating power now with a car dealer whose sales are down than you would have during more robust times.
If you aren’t in a position to make bigger financial moves, there may be other opportunities: opportunities to seek better employment or otherwise improve your situation. Uncertainty increases both risk and opportunity.
The Bottom Line
The bottom line is that there is no silver bullet. There is no magic pill. There is no immediate solution to many of our newer challenges.
There will still be a future. We have faced challenges before and we will face them again.
The key to facing uncertainty is planning. We need to think through our options and give credence to our worst-case scenarios, knowing their possibility may be higher in the near term than at other times.
There is also reason to be cautiously optimistic. All is not doom and gloom. We need to prepare for challenges while looking forward to better times.