Why Emotions Often Overtake Personal Financial Analysis
I was talking to a friend who was considering buying a cabin.
“The house is an A-plus; the land and location are Cs.”
As he spoke, he continued to get excited about the house. But here’s the thing: are you really buying a cabin or a seat?
In business, one of the things we do when making decisions is to do a cost-benefit analysis. But in our personal lives, even if we do that, we tend to overweigh one way or the other.
Let’s go back to the friend’s cabin. There are definitely benefits to jumping on it. It’s a great house, the market is tight, and they have found a place and can therefore enjoy it sooner. Interest rates are low enough that they can easily afford it, and they have one foot in the lake where they believe they will eventually settle. But with emotional decisions like this, we can overstate the wrong things.
There are costs with this decision that are more difficult to estimate. They seek an outdoor lifestyle – being on the lake, making bonfires at night, playing on the lawn. The time they will actually spend in their home may be much less than the time spent outdoors.
This location means that they will not be close to places that are already important to them, thus creating a constraint on the amount of visits they can make to these places. Depending on how little they will initially use the cabin, the cost of ownership translates to several weeks at the stations they were interested in owning in the first place.
And perhaps more importantly, they can eventually fix a house, but they can never fix a location.
That doesn’t mean they shouldn’t buy this place, but it does mean that some steps could be taken before they find themselves making a decision they might regret.
With houses and cottages, the first step before you start looking is to establish a list of criteria in order of importance. Weigh each criteria from 1 to 10. When you start looking, be sure to only consider places that meet your highest criteria. This saves you from getting frustrated and suddenly saying, “I’ll take it,” because you found a few things that got you excited, even if they didn’t tick a lot of boxes.
Next, consider your sense of urgency. Worrying that the market is slipping away from you is not a good reason to buy something you don’t want. Your age and that of your family can create a sensitivity to time, but not the fear of missing something.
Then think about other potential alternatives that might not meet your long-term goals, but might better help you end up getting what you want. Our clients are selling their homes and don’t have a good idea of where they want to live. We encouraged them to rent for a year in the neighborhood they are considering to assess their comfort.
There’s no doubt in their minds that they’ll be buyers, but rather than make a hard-to-correct mistake, they’re willing to tolerate the perceived downsides of renting.
The benefits are almost always easier to grasp than the costs. You love your workplace, but are frustrated with the pay. A job offer comes with a nice pay rise. It looks good?
There are a number of costs to consider before jumping in. How do you determine if the environment is one in which you are likely to be happy? What are the development opportunities in the new position? What are the switching costs for benefits such as profit sharing?
If you’re seriously considering quitting a job you love with people you love, you might want to risk talking with your current employer about what you’ve learned about compensation. In companies where salary ranges are tight, they may not be able to do anything. Or, they may indicate that they don’t think it’s in their best interest to keep you around. But isn’t that the information you want before you do something so upsetting, even if it means hearing disappointing comments?
How about college? The benefits of a private school can be smaller class sizes, a chance to be alone, potentially some status. Yet the costs can be student debt that prevents you from pursuing a field that interests you the most or having to delay your higher education, finding a companion who can keep you away from home permanently or finding yourself with a list of smaller contacts if you eventually back off.
Everything has costs and benefits. Weighing them accurately will lead to an A-plus life.
Ross Levin is the Managing Director and Founder of Accredited Investors Wealth Management in Edina.