Too often, we think of our financial decisions as being made in a vacuum. For example, we figure that the investment choices we make only affect us in terms of gains or losses. Or the decision to fund a 529 education account only means your child will have a better chance of making it through college without needing massive student loans. However, that’s not really the case. All your financial decisions will have a ripple effect. These waves will certainly impact other areas of your life (and the people in them).
Wide Ranging Impact of Financial Decisions
The financial decisions you make will have a very real impact on other areas of your life. They can even influence the outcome of other financial goals, like saving for a house or retirement. It’s important to understand that your financial decisions are interrelated. You should make an effort to see the big picture, rather than make your financial plans in isolation.
From taxes to debt, to how you spend and save, your money decisions will ripple through the sea of life. They will affect you and your loved ones for years to come. Do you take any of the long term effects into account when you make your financial decisions? Do you even know enough about them to make informed decisions? Let’s dig a bit deeper.
Taxes Can Kill Your Investment Edge
Selling a stock might seem like a good idea, but have you thought about the tax implications? Don’t forget that you have to worry about both long-term and short-term capital gains, as well. That’s why it’s so hard to beat holding index funds long-term simply by buying individual stocks.
Look, I know what you’re thinking. It seems like people are making money left and right these days by latching onto meme stocks. It’s hard to resist trying to pick the next GameStop or Tesla. But let’s think about it for a second. Short term capital gains can be as high as 37% (and that’s only counting Federal tax rates). Once you add in state taxes, some people are paying more than 50% of their gains to Uncle Sam.
What are the chances that those stocks will be able to double the performance of a well-diversified index fund portfolio year in and year out? History tells us that chances are slim.
If you are planning to dip into individual stocks, at least consider your future tax situation when you buy. Can you reduce your long-term tax liability by using tax deferred (or even tax free) investment accounts to purchase investments?
Think Twice Before Helping Your Kids with College Costs
Consider how much you can really afford to set aside for your child’s education. While you might want to ensure that your child doesn’t have student loans, what is the long-term cost? Are you taking money away from your retirement to fund your child’s education? Remember that your kids can always borrow to pay for college, but you won’t be able to borrow money to fund your retirement.
Sure, graduating debt-free beats being drowned in debt any day of the week. We’re not arguing that. However, a child who doesn’t need to worry about money at all also won’t get a chance to feel the weight of that debt. It’s still an important lesson for them to learn, as they navigate one of their first large financial obligations. Honestly, paying for their entire college education is a bit like spoiling them. They may get used to having everything handed to them. That could make for a rough entry into the “real world” when school is finished.
If anything, you can always help them pay the debt off after they graduate. But they should still be paying at least some of their own way.
Debt-Funded Toys Can Drown You
Toys are fun. They help make life worth living. However, what will cost you in the long run to make that unnecessary (but oh so cool) purchase with debt? It’s one thing to borrow for a home, or your main family vehicle. Those things are basically necessities. But borrowing for a fancy sports car? Or a boat? Or a brand new iPhone every single year? By the time you pay all that interest (and calculate how much you could have earned if you had invested the money instead), you’ll be sick to your stomach. You might find that the investment growth would have paid for the toy over and over again. I’m not even exaggerating.
I’ve talked about how some of my investments have gone up tenfold by now, over almost three decades. Let’s say I said no to my desires for a new iPhone and added that money to be invested. If your investment continues to grow 10% annually (a reasonable return to assume over the very long term), you’re talking about just the growth paying for an iPhone every two years. If you waited for the pot to grow to ten times the original amount, just the investment growth would pay for an iPhone every year.
Instead of being patient, what do you have to show for making those splurge purchases? Only years of extra debt and thousands of dollars in extra interest payments. Do you even remember half of the things you spent a fortune buying because you “had to have them?” We didn’t think so.
Prioritize Your Financial Goals
As you make financial decisions, do so with an eye toward the future and toward your overarching financial goals. In order to incorporate all of your goals into a financial plan to guide you through the future, you need to prioritize. What are the most important goals you have?
Take a step back and assess your situation. You may even find that you aren’t satisfied when you think about money. The good news is that this isn’t uncommon and that you can fix this. Here’s how:
Decide What You Want from Life
Decide what you want from life. Think about what is most important to you. Family? Faith? Community? Travel? Nice things? There are no wrong answers. It’s just about what you want most in your life.
Once you decide what really matters to you, you can figure out what steps you need to take in order to reach your goals. Really understanding your priorities is key to success in this matter. If you don’t know what you want, it doesn’t really matter in the end. Figuring out what you want from life is essential if you want to incorporate that into your spending plan.
Identify the Spending That’s Holding You Back
After deciding what you want in life and the steps you need to take to achieve it, it’s time to look at what might be holding you back. When I first looked at the way I used my money years ago, I realized that I spent money on things I didn’t care about. I value experiences and the occasional new gadget, yet I kept spending money on conveniences that didn’t matter to me before.
I also realized that I had to spend more time working because I was paying for an expensive lifestyle that didn’t offer me much in the way of satisfaction. Changing things around and cutting out the spending that didn’t matter to me freed up quite a bit of money for me to put into what brings me satisfaction. I could have reduced my workload then and there because my simpler lifestyle didn’t require as much income to maintain. I didn’t though.
You Have Choices Once You Free Up Your Resources
Instead, I kept the peddle to the meddle and now I could afford to cut back if I wanted to and still enjoy the experiences and occasional frivolous purchase. I could even add back all those conveniences I gave up if I really wanted to.
It can be hard to change some habits and while contending with the need to pay down debt. However, if you can bring your spending in line with what matters to you, you’ll feel better about your situation and you’ll eventually be able to dig out of the debt hole.
Plan Your Resources Around Your Goals
Don’t forget long-term planning. You’ll want to plan your financial resource around the specific goals you have for the future. For me, my priorities include setting money aside for emergencies and for retirement in addition to taking care of basic needs like food, shelter and clothing.
I also make sure I have the time to volunteer in the community and spend time with my family. I’ve also started a “no guilt allowed fund” so that I can spend it on whatever I want as long as that account balance doesn’t go negative even if the purchase sounds irresponsible. That way, I can free myself from feeling bad as long as my long-term milestones are being met.
Financial Goals Should Be Personal
What about you? Do you want to retire with a certain amount of money? Pay off high interest debt? If these are your main goals, it’s a good idea to make sure they are taken care of first. Figure out how much money you need to commit to make it happen. You can then commit lesser amounts to less important goals.
Creating a plan for your resources, based around what you want your life to look like, can help you trim the fat from your budget. You’ll live a more satisfying life to boot.
Going Back to Taxes…
This bears repeating because taxes are such a big part of many financial decisions. Don’t forget to weigh the long-term tax consequences of your money moves. One of the things I’m really looking into is strategic Roth IRA conversions. By converting pre-tax money to a Roth and paying the tax obligations from other source to keep the IRA balance the same, I’m essentially increasing my tax-free space. Of course, this is only advantageous if my tax bracket will be similar in retirement than it is now. As it’s a big if, how much to convert each year and whether it’s even a good idea is something that needs to be worked out and carefully examined.
In this case, a tax professional or financial planning professional can help create a play that works for me. Even if I have to pay for the privilege, this could result in a greater chance of overall success. View your finances holistically, and you’ll be more likely to meet more of your financial goals.
The Bottom Line
It’s important to carefully consider your financial decisions and determine whether or not they make sense in terms of your overall goals. Really think about the situation and what matters most to you.
What do you want to accomplish with your money? Don’t just look at what’s in front of you. If you make certain decisions now, what will it mean later?