What are the things you need to know to make the best financial decisions? I’ve got examples of good financial decisions, and 7 rules to follow to make your own.
Making financial decisions – especially big financial decisions – can be so daunting. What if you make a bad financial decision? What if you miss out on opportunities only because you didn’t know any better?
Fortunately for you, there’s a set of rules that, if followed, will almost guarantee you’ll make better financial decisions. And not just better ones, but the best financial decisions in the given situation you find yourself in.
Before we dive into those rules, I want to first show you examples of bad financial decisions, then examples of good ones, in my own life.
Examples of Bad Financial Decisions
You might be surprised to hear this from a money blogger…but I’ve made some bad financial decisions in the past. Everyone does. That’s why I like to talk about how money mistakes can actually be your best teachers.
Here’s some examples of bad financial decisions:
- Plunking Down Most of Emergency Fund on House Down Payment: It’s true…we put most of our emergency fund down on our home down payment as first-time homebuyers 9 years ago. And you know what? One month later, my beater car died, leaving us as a one-car family. *womp, womp*.
- Buying a Beater Car without a 3rd Party Inspection: I love beater cars, and will drive them into the ground (in fact, I’ve NEVER owned a car payment in my life!). But a bad financial decision I used to make was buying a used car without having the $100 or so third-party inspection done by an honest mechanic.
- Not Taking Cost of Living into Consideration: I was laid off from my first post-college job (it was a start-up, and financially failed miserably). Being unemployed left me kind of depressed. Fortunately, I found a job in market research at a company in Florida. However, I’d have to move from Maryland to Florida, and it was a $4,000 cut in pay to start with. I knew those opportunity costs (we’ll discuss opportunity costs later), but I didn’t take into consideration the huge leap in cost of living. Because of that, outside of saving for retirement, I saved basically $0 in the almost two years I lived in Southern Florida.
*shudders*. Live and learn, right?
Okay, now let’s move onto some GOOD financial decisions examples.
Examples of Good Financial Decisions
You need to know what you’re shooting for when making smart money decisions, right? Let me give you three good financial decisions examples, plus talk a little bit about what makes them good financial decisions.
- Saving Up a One-Year Emergency Fund Before Quitting My Job: I had dreams of quitting my day job to pursue my passion – writing about money – full-time. But I didn’t dare to even bring it up with my husband until we had saved up an emergency savings fund that would weather us through an entire year. That was a great decision!
- Going Back to College on the GI Bill: My husband, Paul, and I met while he was in the Navy. He had completed just 1.5 years of college before joining up, and we met while he was stationed in Japan. He went back and forth on whether or not to go back to college in his early 30s, and finally took the plunge. Fortunately, not only did the GI Bill cover ALL costs, but we also received a monthly housing stipend of close to $1,000 for three years (which really came in handy both when he got laid off and when he took a job at a much lower salary for a while). And now? He’s about to accept an offer on a dream job that he NEVER would have been eligible for without his college degree.
So, let’s dig into actual strategies you can use on ANY financial decision you need to make.
What are Three Strategies that You Can Use to Make Better Financial Decisions?
If I had to boil this entire article down to just three strategies you need to make better financial decisions, it’s going to be these:
- Take the urgency out of your decision-making.
- Understand your opportunity costs.
- Test-drive to make sure it’s the best financial decision you’re making.
I want to go way more into depth about each of these, plus give you several more. Keep reading!
How Can I Make My Financial Decisions Better, and How Do I Make Big Financial Decisions?
I’m giving you a set of rules you can come back to again and AGAIN, no matter what financial decision you need to make. Go ahead and save this article to your favorites or pin it for reference.
Rule #1: Pay Attention to Percentages AND Amounts
You can manipulate numbers. Don’t get me wrong – numbers don’t lie. But people can use numbers to lie, either to others, or to themselves.
When you’re making financial decisions, you’ve got to pay attention to both percentages AND to the amounts.
For example, you could see that deciding to move to another state and take a job that’s offering you a 30% income raise. WOW, that sounds amazing! But what if your income was just $1,000/month to begin with? That 30% raise sounds amazing, but in reality, it only comes out to an extra $30/month.
Would moving to take a job that you only would get a $30/month bump in pay be worth it? If you make the decision based on a 30% increase, then YES, it sounds like a clear winner. But if you do the math and figure out the actual amount, suddenly paying to move states and uprooting your life seems like a bad financial decision.
Let me break it down visually for you:
- Would you move to another state and uproot your life for a 30% increase in pay?
- Would you move to another state and uproot your life for an extra $30/month in pay? Uhhhh…maybe not so much.
Now, it could still be a good decision, but only if you take all the other factors and opportunity costs into consideration (don’t worry – opportunity costs are up next).
Rule #2: Understand the Opportunity Costs
With any decision you make in life – financial or otherwise – there are going to be opportunity costs.
What are opportunity costs? They are the opportunities you would need to give up in order to choose something else. For example, if you choose to become a stay at home parent, then you would create a one-year, two-year, or more gap in your resume. That’s a clear opportunity cost, because you clearly cannot be a stay-at-home parent AND work at a company at the same time.
Some opportunity costs are obvious. Like, if you’re going to quit your job to start a business, then you’ll lose your job’s salary of, for example, $50,000.
But other opportunity costs you don’t truly understand until after you’ve made your decision and you’re living with it.
I’ll give you a personal example:
I’m a work-at-home Mom of a child who is currently 3.5-year-olds. We were trying to decide whether or not to place our little guy into daycare for part of the week so that I can *actually* get more work done on my business (working with an infant or a toddler? Yeah…it’s difficult).
Opportunity Costs of Putting our Child into Daycare:
- Approximately $500 (for two days/week, 9:00-2:30 p.m.)
- Less time with our child
- Other people helping us to raise him
Opportunity Costs of NOT Putting Our Child into Daycare:
- Slower business growth (I can’t really calculate the cost of this, but you can bet it’s probably close to $1,000/month)
- Me working on Saturdays, while my husband spends the day with him, to catch up
Hint: Notice that even though this is a financial decision, there are very NON-financial considerations to make? Those need to be included in your opportunity costs list as well!
In the end, we decided to postpone placing our child into daycare. He’s still home with me, 5 days a week. Then on Saturdays, I work all day at a local Starbucks (part of the opportunity cost of my decision – working Saturdays for this Mama!).
And what were the opportunity costs I didn’t truly understand until about a year into after we decided? Well, I also ended up giving up the weekend yoga class I used to go to (since I need that day to work), we now have to squeeze grocery shopping onto a weeknight, which makes for a really chaotic evening one night every other week, and we’ve taken less long-weekend trips to accommodate my work needs.
Still…I’m very happy with our decision! He’s growing up so fast, and this time with him was well worth it.
Rule #3: Take the Urgency Out of Your Decision-Making
This one is MEGA important, so listen up.
If there is just ONE thing that you can do to make sure your financial decisions are as sound as possible, it would be this:
Here's the secret money advice: take the urgency out of your decision-making process.
When you're pressed into making a decision — from sleazy Timeshare sales tactics, to waiting until 11:00 p.m. on the night your health insurance open enrollment closes to figure out what plan is right for you + your family — you are putting yourself under a lot of pressure.
Sometimes pressure works in your favor. Sometimes it doesn't.
I don't know about you, but I don't like pressure when it comes to decisions with my money. I like to look at all angles, run a few excel scenarios, chit-chat about it with my husband, and generally wrap my head around the situation.
I'll bet you don't like pressure when it comes to deciding how to manage your money, either.
I'll give you a scenario in our life where we:
- did not take the urgency out, and had to deal with the repercussions from a poor decision, and
- took the urgency out the second time, and how that turned out waaaayyy better
Our Big Financial Decision the Wrong Way (ouch), and then the Right Way
I love beater cars. You know, the kind you get at 160,000+ miles, pay a few thousand in cash for, and drive into the ground.
In fact, not only have I never owned a new vehicle (and I'm 32, driving since I was 17), but I also have never owned a car payment!
Just like any vehicle, they don't last forever. And in 2011 — after six glorious years with my piece of wonderness (aka my 1997 Chevy Cavalier) — it died on me. Rather, the cost of repairs no longer made sense with the $1500 I had paid for the vehicle.
At the time Paul and I were both commuting to different jobs with a sizable distance between each other, and did not even consider another option except to buy another beater car quickly.
So, we rushed into purchasing a beater Nissan truck for $3,500. I wasn't crazy about the idea. In fact, my gut told me “no”. But I was overruled by both urgency and my husband, who wanted to get the situation resolved.
And guess what? That truck sucked. It was very rickety on our very bumpy road home each day. It slid in rainy weather. And then…it, too, died (head gasket blew, leaving us a potential bill of $3,500 for a new engine) within two years of the purchase. Not a good decision at all!
Note to truck: thank you for that $3,500 lesson you taught us.
After the truck died, we took the urgency out of the situation. Instead of purchasing the first used car we could find with the Monday morning commute hot on our heels, we rearranged our work schedules and carpooled together. This bought us several months to really search for our next beater car, which we found (and I'm still driving to this day): a 2003 Chevy Cavalier, 160,000 for $2,500 (my first automatic locks + windows).
How to take the Urgency Out of Your Financial Decisions
Perhaps you won't be able to carpool with your spouse if you find yourself in a similar situation, or maybe that scenario doesn't apply to you at all. There are still several things you can do to take urgency out of your financial decision-making equation the next bind you find yourself in.
Take this smart money advice to get money smart:
- Fill Up Your Emergency Fund: I can't stress this enough, as it takes the urgency out of so many financial decisions. If you have proper funds to take care of something, then you don't have to go with the cheapest option (surprise: cheapest is not always best). It also leaves you feeling more confident, and less at the whims of, say, a pawn shop owner or payday loan lender. Since you now know that building an emergency fund isn't as annoying as you originally thought, then get to it! It's just one of the best smart money management techniques.
- Don't Wait Until Last Minute: If you know a big financial decision needs to be made, like which healthcare plan to enroll in, what home to buy before XX deadline, etc., then please don't wait until the last minute. Late night cramming sessions — while they might have worked in college — likely won't work well here.
- Make Temporary Arrangements to Buy You Time: In our situation, we spoke to Paul's boss and changed his schedule temporarily to accommodate us. Other ways to buy time could be short-term service plans to get you through while you're making your decision, asking a family member to temporarily do something for you while you find a replacement option, etc.
Hey, if you made a financial decision under the gun, it's likely not all bad. And some situations — no matter what — will still be urgent. Even with our sucky truck decision, we were able to donate the car to Purple Heart, gaining a $1250 tax deduction that year. But if you can take some deep breaths during your next financial decisions and try to eliminate the urgency (or at least dull its impact on you), then you're going to make solid decisions that will work for you beyond just a band-aiding of the situation.
Rule #4: Keep Perspective on the Value of Your Time
I talk about money ALL the time here (which makes sense, since it’s a money blog!).
But you know what? Time is actually more valuable than money. I absolutely NEVER would have said that statement in my twenties. But the older I get? The more I realize the truth of it.
I can make more money. I can save more money. But time? I can’t get any of that back.
I can also use money to BUY some of my time back, which is a whole other blog post. What I actually want to talk about here is, when making the best financial decisions you can, you have GOT to take into consideration your time.
And, my friend? I can tell you from experience that not every financial fight is worth it.
In my own life, I have several examples that shaped this opinion of mine:
- That Time I Braved Traffic Across Town to Stock Up on $0.20 Cans of Tomato Sauce: After an hour — to get to the store, make my way to the cash register, pay $1.20, and drive home in rush hour traffic — I was able to add 6 more cans of tomato sauce to my already overflowing stash of 20 at home. Ummm…perhaps my time had been better spent, I don't know, defrosting my freezer?
- Hour-Long Service Call to Amazon.com to get the last $12.72 Charge on a Gift Card: Just the other day I was attempting to make a purchase off of Amazon.com and had to call them about an issue using credit card reward points to pay for a purchase. Through sales, free shipping, and a Christmas gift, I was able to get an order of goodies down to just $12.72. But that wasn't enough; I wanted to use my credit card reward points — which you could now sync with their system — to cover that last bit. The phone call with them ended up lasting an hour. Utterly ridiculous use of my time. In the end they awarded me a $20 credit for that utterly ridiculous use of my time, so it wasn't a complete loss. But I would have enjoyed that hour instead.
- Bank Offers for less than $150: In my 20s I would have eagerly jumped at every bank offer that came my way, plastering the city of Houston with bank accounts in my name that probably housed just a few hundred dollars each. Now I'm much pickier. The fact is, a bank offer is a great thing. But it also takes time and a little juggling of details to get right.
It's like that one driver who cuts you off, then cuts off the guy in the right lane, then swoops in ahead of the driver in front of you and cuts them off…only to meet up with you at the next red light.
And you're talking to someone who took a good deal of her 20s to figure this out (by the way, that is not a statement of regret; having been in a different place at least in my early 20s meant that I was able to squirrel away extra cash that has directly benefited me today). Of course, when you're just starting out and there is not a lot of money foundation to go back on, the small financial fights are a bit more important.
But as things settle down, debts are paid off, emergency funds are flush, and careers are expanded…time and its preciousness become an ever-increasing determination in $0.20-can decision-making.
Rule #5: Check Your Emotion Level
In order for you to make the best financial decisions possible, you can’t be highly emotional.
It’s like, the two work against each other.
This means, you can’t make smart money decisions when you’re in fear, when you’re overly attached, when you’re grieving, when you’re overly ecstatic, etc.
Making long-term decisions when drenched in fear is next to impossible.
Your body and mind are not set up for it. When you feel fear, it’s all about survival.
If there is anything you are fearful of, financial or not, you have got to get out from the fear before you can look at the situation and make decisions that will impact you for the better in the long-term.
Decisions made from fear ensure that you will continue in survival mode. Survival mode is very important, and I’m thankful to have the type of reflexes that I do. But to ensure that we all do more than just survive; we must eradicate our fear.
After all, survival mode cannot last forever. And who would want it to?
Rule #6: Give Your Financial Decision a Test-Run
Ready (you think) to make that big financial decision? Like purchasing a new home, combining households, having a baby, or any other utterly life-changing event?
The fact is, you can usually figure out whether or not you can afford the purchase price of the next big move in your life. And not just the purchase price, but also the monthly costs that will be introduced into your life as well as a result of the purchase.
It's called making a money plan.
The fact is, you can usually figure out whether or not you can afford the purchase price of the next big thing in your life.
I mean a new home has an asking price and you can either save up for that amount and/or get a mortgage for the rest or not. But what about the revolving monthly costs? Can your budget and cash flow absorb the extra costs (without making you sorry you did it because you can't afford the rest of your life anymore)?
That's what we've got to find out to make sure you don't get stuck in a sucky situation. You need a money plan to help you with how to manage your money as you move forward in your life.
Foolproof Step #1: Conduct Some Research
Ask yourself this question: what are the extra revolving monthly costs involved with this next big thing in your life?
Then write down your answers.
For example, with a new baby, you will have medical costs, supplies, a health insurance premium increase, etc. If you're looking to purchase a new home, you'll need homeowner's insurance, property taxes, repair money, etc.
Foolproof Step #2: Set Up an Imaginary Budget
Research an approximate price for each of the revolving monthly items on your list, and write that amount next to the item. Add up everything to get a figure for how much extra per month you will need to have in order to afford your purchase.
This is the amount you need to test out.
Foolproof Step #3: Test it Out for a Few Months
You now want to put a stress-test on your finances to see if you can do it (and do it at a level where you’re comfortable). So, each month for the next several months you need to set aside that figure from Step #2 into a savings account as if you were already paying those costs.
Bonus benefit to doing this money plan stress test: you’re simultaneously saving up towards the purchase price! It's really a saving money plan.
I would do this for at least three months to really get a sense of how it would be like living under this new cash flow strain.
After a few months of this, assess where you are. If you have a partner, talk to them about their experience. How's it been? Did things work smoothly, or did you feel constrained? If you feel constrained, are there ways you can ease that (such as earning more money or shopping around better for greater deals)?
Bonus Foolproof Step #4: Another Stress Test
Technically, you’re finished (and way ahead of the game) if you did those three last steps.
But I want you to do one more thing because it’s what I would do if my own money was on the line. Run a few different scenarios. So how would any of the following change how you could weather this next financial step:
- Losing one Income: going down from two incomes to one income (due to a layoff, one parent staying home, etc.), or with one partner having maternity leave pay only for X amount of months
- Holding Two Mortgages: Being unable to sell your old home for several months before purchasing your new home and taking on a new mortgage. How would you fare then?
I would love to know what your next big thing is, other stress tests you’ve put on your money plan scenarios, or stress tests you’ve experienced hands-on in the past. Who knows, you might help someone else out who is thinking about doing what you’ve already done.