5 Fundamentals for Great Financial Decision Making
The quality of our lives is greatly influenced by the decisions we make. Unfortunately, we aren’t born with the ability to make the best decisions. We are usually irrational human beings. The only way to be great decision makers is to learn from our mistakes, learn from others and to understand the consequences.
As money revolves around our entire life, the financial decisions we make affects what we do, what we have and where we live. We can make thousands of financial decisions in our lifetime. Some are as important as buying a house or starting a business, whereas others are as little as deciding which brand of toilet paper to buy.
The financial decisions we make today will shape our finances and ultimately our lives in the future – for better or for worse. Important decisions should therefore not be made lightly.
Here are 5 factors to help you become a better financial decision maker:
1. Remove Emotional Influences
One of the main reasons for making a bad financial decision is we let our emotions get the better of us. Too often we make bad decisions when we are in a negative mood, so it is important to stay positive, rational and objective. If you have bought something on impulse to make you feel better you are not alone. Do not persuade yourself that that going on a shopping spree will make a situation better or make you more happy.
Good financial decisions are made by having a clear focused mind. Look at every decision with a neutral, objective perspective. Get rid of all emotional connections with brands, do your research and consider all other options and alternatives. For example, when purchasing white-goods or furniture, consider a cheaper brand, wait for a good bargain or buy second hand. By focusing only on the financial side when spending, you have the potential to save a lot of money.
2. Have a Long Term Vision
Often we believe that the decisions we make today will only affect the present moment or near future. However, it is important to consider the long term consequences of a decision, which can sometimes not be foreseen. Your decisions should be aligned with your long term goals, such as increased wealth, a good retirement or an overseas holiday. The best decision to make today is the one that your future self will be proud of.
“The decisions you make today will shape your tomorrow” – let’s hope it is a good one.
One of the best decisions you can make for the future is to save and invest as much as you can today. Time is money. The earlier you save, the more interest you can earn. This means your money will work for you, rather than you having to work for money. The future is always uncertain, so it is important to plan and prepare for a good one today. Every dollar counts, don’t waste it!
3. Understand Opportunity Cost
Opportunity cost is the forgone benefits you could have received from an alternative action. Your resources are limited: there is only so much you can do with your time and money. The concept of opportunity cost when making a decision allows you to determine the best possible way to make the most of your money and life. It is nearly impossible to make the perfect decision, but it is always good to try our best with what we have and what we know. Consider all options carefully by doing a pro/con analysis of each.
For example, if you decide to invest $1,000 of savings into the stock market earning 3% per year, and a managed fund is earning 5%, the benefits forgone is 2%. You could have also used the $1,000 to reduce debt or go on a holiday. Opportunity cost can be used for all decisions, such as where to travel for a holiday, or which property to buy.
4. Get a Second Opinion
The wealthy will always hire someone smarter than them when they are unsure about something. That is why they spend a lot of money on professional services, such as lawyers and accountants. Everybody knows something that you don’t – just ask.
Individually, we are not likely to make rational decisions. But with a great team of experts, the best decision will be easy to make. The benefits of their advice will likely be more than what it costs.
Advice from friends and family, and people who have already done what you want to do are great sources of wisdom and support as well, and probably won’t cost you anything.
5. Set Priorities
Since your time and financial resources are limited, your decisions should reflect what matters most to you. If you like to have the latest trends in fashion and tech, your credit card debt and spending habits will reflect this. Focus your attention on the big long term decisions, rather than insignificant everyday choices.
Financial decisions will be easier to make when you follow a budget and have defined goals. A budget will allow you to allocate your money in areas that matter most, and goals will allow you to make the right decisions to achieve what you want.
No financial decision will ever be perfect, but with the right mindset and strategy, you are able to create a better future and achieve what you want. How you manage your finances can and will affect your life. It is too important to ignore.