Money Decisions: A How-To Guide
The universe is full of advice on what to do with your money. “If X happens, then do Y.” And if it is a simple problem, that may be all that you need to know. But it’s often the case that even after reading the prescription, you are still unsure what to do. “If I do Y, then Z will happen. Is that good or bad?” How do you make the decision whether to proceed?
If I take this action, will I be more financially stable today or less so?
Spoiler alert: Being more stable today is better than being less stable.
Here’s an example: You have a choice between using your recent windfall (a tax refund, overtime pay) to make an extra payment on your frightening credit card balance or sock it away In your anemic savings account. Both of these are virtuous actions; which one is better?
The basis of financial stability is having cash in the bank. It is not any more complicated than that. If you are down to your last $100, then any windfall needs to go there, regardless of your credit card balance and its extortionate interest rate. Adding that fantasy football winnings to your regular credit card payment may feel like the righteous thing to do…until your work hours get cut next month. You can’t pay your rent with virtue. Every action you take in your financial life must be geared towards constructing a solid foundation first.
How does this decision affect my future stability?
When you feel as if everything in your financial life is chaos, it can be hard to see beyond the immediate and consider how your decisions today can affect your future. A great example of this was a 2021 academic study that found that faced with the possibility of both credit card and student loan delinquency, respondents were far more concerned with their credit card debt and would prioritize that. The researchers hypothesized why that might be (for example, the social acceptance of student loan debt versus credit card debt), but my point is this: As nasty as a delinquent credit card account can be in the near term, it is nothing compared to the long-lasting damage that can be wrought by becoming delinquent on a federal student loan.
More hopefully, perhaps your choice is between an extra deposit to your child’s college fund versus your own retirement savings. If you have run the numbers and can see that you are not on track toward your retirement goal, then your decision must prioritize your future stability.
What is the opportunity cost of this decision?
This can be a tough one because, just as in the example above, you may be debating between two options, neither of which is “bad.” My favorite dilemma? “Should I pay extra on my student loan, or invest more for retirement?” In this case, it’s (almost) all about the cost of the road not taken.
The math is pretty clear: If you are investing for the long term, it is likely that your investment return over time will exceed the interest rate on your student loan. But even more so, when investing for retirement, the greatest asset you have is time. The difference between investing $200 a month (at 7%) for 10 years versus 20 years is more than $67,000. While you can (and should) ramp up your savings rate when that student loan is finally paid in full, it can be hard to make up for lost time, even as you save by paying less interest.
At the end of the day, when faced with the option of two not-bad ideas, you will make the decision that feels most right to you. My only ask is that you do so with full knowledge of the opportunity cost of your choice.
As you see, the answer to most financial questions is “It depends.” My goal? To show you what it depends on.
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