A lot of our thinking about money revolves around the gains: I’ll invest X to get returns of Y per cent in the long term; I’ll buy this couch because it will brighten up my apartment and make me happier. But when it comes to financial decisions, it’s also important to consider what you’ll be giving up.
What is she thinking? Image: Pexels
Because we’re human, we make impulsive decisions all the time. But rather than rushing decisions or simply going through the motions, really thinking about what we’re giving up when we make these decisions is a way to take a long-term view of our finances rather than a myopic one.
This is something Jonathan Clements recently got into on his blog, HumbleDollar:
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.
But this extends far beyond whether or not we should impulse shop after a hectic day at work. It’s something to consider for all money-related decisions. Writes Clements:
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.
This is something that’s been particularly relevant in my life as I grapple with how to pay for a studio apartment in New York City. Intellectually, I know I’ll need to sacrifice other luxuries that I’ve gotten used to over the years, and that it will be something of a barrier to my other financial goal, which is to build up my liquid savings. But there are other questions to consider, too, per Clements: How will this decision impact my happiness? What are the risks involved? Do I need to make other financial changes? What are the additional costs involved that I’m not taking into consideration?
This is by no means a new concept – we’ve written before about hitting the pause button and instituting a rule with yourself before you buy something – but it applies well beyond the realm of impulse spending. Every financial expenditure means you’re giving up something else, whether that be an appropriately diversified portfolio or employer-sponsored health insurance. You want to go into these types of decisions with a clear head and understanding of what you’re potentially sacrificing. As Clements writes, not every decision we make reverberates across all of our finances, but “those reverberations can come back to haunt us, so it’s a crucial consideration”.