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WHEN WE MAKE financial decisions, we usually have a pretty good idea what we’re getting. But what are we giving up? That, I believe, is the crucial, unasked question.
Think about any financial choice, whether it’s the shoes we buy, the stock we purchase or the kids’ college degree we promise to pay for. All too often, these are snap decisions. Captivated by the bright shiny object in front of our eyes, we make an isolated choice—and fail to grapple with the bigger picture.
How can we improve our decision-making? It starts with hitting the pause button, so the slower-moving contemplative part of our brain gets a chance to wrestle with the faster-moving instinctual part. And during that pause, we should ask ourselves: What am I giving up?
If we splurge on the new shoes, we’ll have less money to spend on other items, either now or at some future date. If we purchase a stock, there’s a world of investments we’re effectively choosing not to buy. If we pay our children’s college costs, we’ll have fewer dollars for other goals, notably retirement.
Even if we ask about the tradeoff involved—or what economists call the opportunity cost—there’s no guarantee we’ll make the right choice. Often, acting on our first impulse is simply too alluring. But at least asking the question forces us to consider the issue, however briefly, and maybe we’ll have the presence of mind to weigh the alternatives—and perhaps even summon the willpower to choose a different path.
As we mull those alternatives, there’s a slew of additional questions we should ask, including how the decision will impact our happiness, what it’ll cost and what risks are involved. I would also ponder a question that isn’t asked nearly enough: Should the choice prompt me to make other financial changes?
This question doesn’t always come into play, because not every decision reverberates across our finances. Still, those reverberations can come back to haunt us, so it’s a crucial consideration.
For instance, if we dump a bunch of money in a new mutual fund, we may end up with too much exposure to one part of the market, especially if our new fund has a similar mandate to others we already own. If we buy a house, we may need a larger emergency fund to cover any unexpected expenses, and perhaps more life insurance so our family could pay off the mortgage if we died. If we quit our job to launch our own business, we’ll likely need to buy our own health insurance and maybe purchase disability insurance as well. We may also need to think anew about our retirement savings strategy and probably keep more cash in the bank.
Follow Jonathan on Twitter @ClementsMoney and on Facebook.
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