Tips | August 26, 2015

Six questions to ask before making a financial decision

Popular wisdom suggests pausing for a moment before buying an item and asking yourself: “Do I really need this?" Asking the right questions may also help with bigger financial decisions.

Our natural human biases can make it difficult to make smarter decisions. Asking certain questions, however, before taking a decision may cast light on the implications of a choice – for example, the toll on long term financial goals from spending in the moment. This might also help people decide which factors can be controlled and where changes might be made.

1. What are my goals and aspirations? Ask what your long term and short term aspirations are, and work out which are the most important. One way of exploring this question is to imagine an older version of yourself, in the future. As explained by behavioural economist Dan Goldstein in a 2011 TED Talk, your hopes and needs might be very different from today. This can also help avoid a tendency to favour how things are today – also known as present bias.

2. What are my options for reaching these goals? There may be more choices than you realise at first. Consider all the possibilities, one by one. Remember that the way options are framed can affect the way they’re perceived – nudging towards a specific choice. This can be dangerous when trying to make an objective, unbiased decision that’s best for an individual situation. This article suggests mental “nudges” that can be applied to help you stay on track.

3. What are the benefits of each potential choice? How might each option help you get closer to your goals? Some potential benefits might be obvious; others less so. Are the benefits really likely to happen – or are they based on a prejudicial view of a situation? How might making these choices affect other situations or people involved? Don’t be afraid to reject choices in favour of new ones when new facts come to light.

4. What will I have to sacrifice for each choice? What are all the risks associated with each option? Work out the possible costs in financial terms. And is there a hidden price to pay? Once you select an option, what benefits or opportunities down the track might be lost? It can make sense to discount short-term gains for better profits over the longer term. Although, as in the famous marshmallow experiment, people typically find it difficult to delay a chance of immediate gratification in favour of something better later on.

5. What do I stand to lose? What’s the worst thing that could happen – and can I live with it? Fear of losing something – loss aversion – coupled with natural inertia can stop us making changes to improve our lives. Sometimes these fears aren’t realistic. However, even the best decisions won’t completely protect you from bad events or chance misfortune. Take some time to think about the potential losses that might stem from taking a specific decision and how you might recover from them. Factor that into your ultimate course of action.

6. Are there any alternatives I have not yet considered? For example, if making a decision involves taking on additional debt, explore whether there is another way to reach the goal? Would a delay reaching the goal make a difference? Or is the benefit dependent on a particular time frame? Situations change over time too, so keep up to date. It might pay to build in enough flexibility to allow a change in direction later on if necessary. Don’t get hung up on sunk costs; sometimes the smart move is to learn from your mistakes, move on and cut your losses. Knowing when to walk away from a poor choice is a key skill too.

Final thoughts
Ensure a decision is made, once things have been thought through. Develop a concrete plan and be patient. Each step should be towards a financial state that will enable you to meet a goal. Keep a picture in your mind of what you are trying to achieve – or even take an actual photo to inspire you, as this article suggests - and place it somewhere you will see it. Perhaps create a special bank account and name it after a goal. It’s amazing how simple acts can provide real motivation to follow a dream.

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eZonomics team
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