All your decisions are actually financial decisions . That’s because every decision you make has some financial aspect to it. Can you think of any decision that is devoid of financial fallout? I can’t.
We talk a lot about what to do when it comes to money, but we rarely examine the decision making process that is behind the conclusions we come to. That is an opportunity too rich to ignore. When you use a stronger decision making process, you’ll absolutely have better outcomes and make far fewer money mistakes.
Where is the flaw in the process now?
The difficultly people experience when they try to make financial choices is the noise in their heads. We all have competing forces running around our brains pulling us in different directions. The loudest noise usually carries the day and we forget about other financial needs and considerations. This in effect ends our process far too early and we make decisions based on only a small amount of information and considerations.
What are the different considerations?
I believe they can be broken down into four quadrants:
Short-Term Emotional
“I’m worried right now. DO SOMETHING!”
Long-Term Emotional
“I’m worried about how this is going to impact my retirement/child’s college funding down the road. DO SOMETHING!
Short-Term Financial
“My account vales declined this month. I have to do something differently. “
Long-Term Financial
“My account value has not increased over the last 5 years. Do I have to change my strategy?”
As I said, when you make a decision, you often latch on to one of the 4 internal messages and ignore all other aspects of the problem and this is an error.
Unfortunately, the people who struggle most financially are those who make their decisions in the short-term (emotional and financial) arena to the exclusion of all else. And the people who are most successful in creating wealth (but not necessarily the happiest) are those who put the most weight on the long-term emotional and financial considerations.
How do you find a balance?
1. Identify the forces.
Write down the long/short financial/emotional forces that are at play to determine why you feel drawn to one course of action versus another. This exercise really helped my friend Andrew recently. He relocated to Hawaii in order to live the good life. He opened his small business full of optimism and good intention. His business did well but he quickly found that some of the vendors he was dealing with were acting in bad faith. Over the period of a month Andrew had 3 or 4 landmines blow up in his face. He finally hit his limit and was ready to pack it in and move back to Los Angeles.
We went over the matrix above. Andrew recognized that his short-term emotional needs were for security. He felt extremely insecure with all the problems he had encountered. He felt taken advantage of and angry. He desperately wanted to be back on solid ground.
In reality, none of the problems caused by the vendors were going to threaten Andrew’s ability to make a living – but it sure felt like it. In fact this drive to shut it all down and move back to Los Angeles was all based on his short-term emotional needs. When he took a step back, he saw that his needs and feelings were appropriate and fair but it would be a mistake to allow that one aspect of the situation drive the decision.
Andrew revisited his long-term emotional and financial needs and realized that he needed to stay in Hawaii in order to achieve those goals. Moreover, he realized that all he really had to do was change his vendors and put a better accounting system in place to solve his short-term emotional needs. There had been no fatal mistake committed. He could recover easily from the bad business that had gone on. Andrew was only able to recognize this once he looked at the quadrant and evaluate his situation accordingly.
2. Ask Questions
People lose money when they stop asking questions. It is super dangerous when you think you know something that you really don’t. In fact, do this enough and you’ll go broke.
Getting back to our quadrant, it’s pretty easy to know how you feel about what’s happening short term and long term. Just ask yourself and start writing down what comes up.
While it may be easy to get in touch with your feelings, it may be more difficult to understand the financial fallout of your actions. Do you understand how investments like mutual funds work? If not, find out. Don’t assume you understand. And don’t assume that just because you think you know something that you really do. There is no shame in admitting that you need to learn more.
A friend of mine recently bought a rental property. He told me why he bought it and how he financed it. Then he asked me if his thinking was on track or not. We went through it and his process made sense to me. I didn’t really add much to the conversation. I was more of a sounding board for him. Use that process. Just running your ideas by another person is invaluable.
3. Rank Your Concerns
This may sound crazy coming from a financial advisor but life is not all about money. In fact, there are many things that are more important than money. But you have to evaluate rationally. Let’s look at our friend Andrew to illustrate this a bit further.
I asked Andrew to detail his short/long, financial/emotional concerns. Then, I asked him to rank them in terms of importance. Here’s what Andrew came up with:
1. Long-term emotional needs – Feel happy with where he lives.
2. Long-term financial needs – Have a sustainable and stable financial life.
3. Short term financial needs – Have good business relations and cash flow.
4. Short-term emotional needs – Feel secure with the vendors he uses.
You can see that Andrew’s long-term emotional needs were most important. Obviously, he needed to correct the problems he was having with vendors in order to do that. In the long-run, his business wouldn’t last if he didn’t have stable partners. But leaving town was no answer. In fact, leaving Hawaii was counter to what was most important to him and his family. Without going through this exercise, Andrew would have felt frustrated and conflicted.
When you are forced to make a decision, what is your process? Do you recognize where using a process like this would have been beneficial to you?
Smart Military Money says
Neal,
I usually apply the five Ws and H process: who, what, when, where, why and how? I recently considered moving to a similar city, which would have affected my finances in the short and long term.
Who is affected by this decision?
What’s the benefit of making this decision?
When will I execute it?
Where could it go wrong?
Why am I making this decision?
How will I be able to do this?
Now there’s bound to be lots of overlap when these questions are answered, but it helps me be thorough and take several looks at the whole situation. Better yet, sometimes I cannot come up with an answer to a certain question at all.
That’s a red flag. This was the case for me before I moved, so I ended up staying because I realized I’m happy where I am.
Thanks for sharing your process, Neal.
-Christian L.
Neal Frankle says
@Christian L,
Great process you have as well. I especially appreciate the “what can go wrong”. W/your permission, I’m going to use that!
Smart Military Money says
Neal,
Thank you. It’s a system that has worked well for me. I can’t say I regret not doing something.
And you don’t need my permission! Use whatever you’d like and share the knowledge.
-Christian L.
Lance@MoneyLife&More says
This is a great process Neal. I tend to think I am more financial minded and my girlfriend is more emotional minded. This matrix makes a lot of sense and might help us understand each other and our thought processes better. Kudos!
Robert Henderson says
Nice article Neal. I agree that too many people use emotion and short-term thinking far too much in their financial decision-making.