Are you finances keeping you up at night? Do you fret and stress and ponder how to change the financial circumstances you are in? We want to share some tips that may just change your financial outcome for the positive.
When it comes to making decisions about financial matter, making the right decision every time is an unreasonable goal for most because it simply isn’t reality.Some things, especially in finance, are out of our control. Many factors come into play and need to be considered to make the right decisions. However, we can raise the odds of making a good financial decision.
When we do that, two things happen:
● We avoid disastrous mistakes that can be hard to overcome
● Our good decisions compound and add up overtime
How do you become a better financial decision maker? Here are three tips that can make you a better decision maker today that will help you sleep at night.
# 1 – Think Long Term
Harvard University Professor Dr. Edward Banfield had a goal. He wanted to learn why some families become financially successful while others struggle to make ends meet.
His original theory was that the answer would have to do with family background, education, IQ, or relationships.
What he discovered was that the primary reason for success was a certain mindset. A mindset he called a long time perspective.
While family background, education, IQ, and relationships could help. Banfield found having a long-term perspective as the most important factor.
With regards to personal finance, this makes sense for a lot of reasons. Most notably is for the impact compound interest has in terms of our financial situation. It greatly complicates it and can be good or bad!
At any time compound interest is working for or against us.
Racking up credit card debt is easy if you’re thinking short-term. Long-term credit card debt makes it all but impossible to build wealth.
Investing can be hard in the short-term. Yet, long-term you’ll thank yourself for making the wise choice as your interest earns interest.
A good strategy is to look at your finances and ask yourself, “What can I do that I would be thankful for in 1, 5, or 10 years time?”
# 2 – Create Better Reference Points
When we’re contemplating a decision we tend to pick the option that feels correct compared to a reference point we’ve set.
Say your reference point for a nice sweater is $100. When you buy a sweater you feel is worth $100 on sale for $80, it feels like you got a great deal.
Making rational decisions dozens of times a day is hard. Reference points are a natural shortcut to help us.
The problem is not much thought goes into the reference points we set.
A good way to overcome this is to set default reference points in which you compare buying decisions.
For example, say you get the greatest amount of satisfaction from spending $20 on a book. So, what that sweater cost you is actually four books.
It helps to have a few default reference points, for the types of purchases that provide you the greatest satisfaction.
● $20 = A Book
● $75 = A Nice Date
● $1,500 = A Trip
Another good tip to add to your mental toolbox, which applies to monthly expenses, is to multiply a monthly expense by 173.
This is the amount it would cost you over 10 years compared to investing in the stock market at a 7% return.
So, if you’re deciding between two homes, in which the mortgage payments differ by $125 a month, it’s not just $125 a month.
● It’s one nice trip every year
● A nice date and a few books a month, Or
● $21,625 more in your bank account in ten years
# 3 – Apply Positive Constraints
In a letter to shareholders, Charlie Munger and Warren Buffett once wrote:“Simplicity has a way of improving performance through enabling us to better understand what we are doing.”
One way Buffett and Munger make better decisions is through constraints. One of those constraints is that they don’t invest in anything they don’t understand.
Buffett even has a big box on his desk labeled “TOO HARD” for the investments he has to turn down which are overly complex.
Buffett is famous for all sorts of his rules.
● He only invests in a company he thinks will be successful 50 years from now
● He only invests in a company he’d be perfectly happy to hold if the market shut down for 10 years
With these constraints, he has missed some opportunities throughout the years. But, what he’s done is avoid the big mistakes. Instead, he’s compounded one good decision after another, which long-term have added up.
Limiting your options through constraints or simple rules can help you make better decisions as well.
Here’s a few rules I’ve set for myself:
● Anything over $100 I wait at least 30 days to buy (and must mention to my wife).
● Never go into debt besides a home
● I allow myself at most 10% of my net worth to be invested any way I want. The rest goes into index funds.
These rules have helped simplified a lot of my own financial decision making. Creating your own set of rules can help simplify and improve your finances as well.
Now that you understand how a long-term mindset can greatly benefit your overall financial situation, set those goals, work towards them gradually, and sleep better at night knowing you have a bright future ahead.
Don’t forget to pick up a copy of The Thrifty Couple’s new book titled: “The 2% Rule To Become Debt-Free Fast,” where they dive into mindset and healthy, gradual money habits to meet your financial goals in record time.
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This guest post is by R.J. Weiss is a CFP™ and founder of the blog The Ways To Wealth. Visit his blog today for actionable, proven personal finance tips and strategies.