MONEY DECISIONS: BEFORE AND AFTER

“Good decisions come from experience. Experience comes from making bad decisions.”

–Mark Twain

Hello everyone.

In the last post, I explored whether retiring early was a good idea.

Of course, I was all in favor of early retirement since that is what I did. And you would not expect me to admit a potential mistake in public, would you?

Well, I did admit it, sort of. I revealed that I came out of retirement during the Great Recession and took a part-time job. That allowed us to refinance our loans and, in turn, purchase a small condo for a family member. It was a once-in-a-lifetime chance to buy depressed real estate and benefit my family.

Sam Dogen, the author of Financial Samurai and fellow early retiree, has also recently decided to work part-time in retirement—at least for a while. His choice was met with mixed public reaction since he was one of the movement’s pioneers.

So, I wrote a post about his situation. And you can imagine my surprise when he responded with a message! The gist of his response is that you can’t always think of everything when making major life decisions. And while you might not want to change, your circumstances might, so you should be flexible.

In the short run, Dogen must rely on his part-time salary income because he decided to pay cash for his new dream home, depleting resources that provided some of his passive income. Put another way, he looked at his current situation (before) and compared it to his future situation (after), which was a possible house purchase. Then he decided to go ahead and buy, but take a part-time job.

That got me thinking about money, what factors impact us, and how we make decisions. For instance, what decision elements should you focus on, and which ones are unimportant? Decisions might include a significant purchase, a life change, a marriage, or almost anything.

BEFORE AND AFTER:

The decision process is a little like mentally taking two snapshots before reaching a conclusion: one before and one after the change. Then, you compare the photos to see the difference. If the after photo looks better, you usually make the change.

I discussed our decision to purchase a new car in a previous post. I will use that as an example to illustrate the process.

Please remember that our old car was 18 years old. That did not mean it was a bad car. After all, to a thrifty person like me, it was just being broken in. However, our concerns were piling up, and we needed to act.

For example, its safety equipment was modern when George W. Bush was president. And as much as we both hated to admit it, our reflexes are no longer as good, the pace of driving is faster, and there is a higher percentage of lunatics on the road than ever. And avoiding them is harder.

Safety and safety features were paramount and our number one priority. That meant we needed to buy something new to get better technology. Besides, we were much more likely to go on long driving trips to see relatives, so increased comfort was a factor, too.

Of course, it had nothing to do with the fact that new cars are nice and boost the ego. I am immune to that sort of emotion. I only drooled on a few of the vehicles we drove.

The potential vehicle change reminded me that being virtuous and thrifty can only take you so far—especially if you have waited 18 years.

So, to summarize, here are the pros and cons of the before and after:

THE NEXT STEP: THE SNAPSHOT VERSUS THE MOVIE

Comparing before and after snapshots is not the end of the story.

To compare correctly,  compare the before snapshot with the after snapshot you anticipate when you finally get rid of your new car—10 or 15 years from now, not directly after purchase.

Looking ahead like that factors in the time element that impacts most decisions.

And there are other time considerations, too. For instance, how could your situation change? A shiny two-seat sports car might seem an appropriate choice–until you have a family to lug around. And it might be easy to get in and out of when you are young–and less comfortable as you age. So, time and changing circumstances also affect decisions too.

THE TRAP OF SILENT COSTS—HOW TO MAKE THEM VISIBLE

Another danger lurks out there. When some of us can’t visualize a problem, we assume it does not exist. Or, we discount or fail to see dangers if they are abstract and not in visible concrete form.

For instance, you can’t see the flu virus. But when you get sick for two weeks, you know it is real.

Therefore, making something visible is critical. It is tough to analyze otherwise. For instance, visibility underpins many popular cash-based financial management systems. Making all payments in cash or using envelopes of money for specific budget items makes an abstract budget situation visible and tangible. It makes “silent” cost real and not abstract.

Decisions like the ones we are discussing are not any different. But, in that case, checklists help. Here are some of the abstract or silent costs that can kill you if you don’t consider them.

SILENT COST 1: MAINTENACE

Buying your first home is an excellent example of how maintenance costs can impact you. Moving from your apartment to your first home might seem like a dream, but what is the cost to maintain everything once you move in? In the excitement, it is easy to lose sight of those costs.

For instance, you must mow the lawn if you have a yard. If you do not do it, what does it cost per week?

The house must be painted every five years. How much does that cost?

When the toilet backs up, you cannot call the landlord. How much do routine repairs run?

You get the point. Maintenance costs are real and must be accounted for in any decision-making process.

SILENT COST 2: DEPRECIATION

Things get old. And sooner or later, you must replace them. For instance, our roof was installed when the Berlin Wall was still standing. The roof is holding, but who knows when it must be replaced? It could start leaking tomorrow.

It will cost a small fortune when it is time to replace it. But it is old, and the replacement cost is inevitable. The cost of setting aside money each month for its replacement is real money and the true cost of depreciation.

SILENT COST 3: COMPLEXITY

My new car is smarter than I am.

Maybe we will fully understand all the features in a decade or so.

So, upfront, you must ask yourself: is greater complexity worth the change? In the case of our car, the answer is yes, primarily because of its safety features. But it is always important to ask yourself if the added complexity of certain decisions is worth the additional time you may spend on it.

Sometimes, that complexity is just not worth it.

SILENT COST 4: THE UNKNOWN

In any decision about change, you are trading the status quo for a situation with unknowns.

That is not a bad thing. But sometimes, there is a cost to making a change that is not obvious at the time.

That is why many people will only make a change when there is a margin of safety involved—like making a purchase with a ten percent discount to create a cushion if something unknown affects it later and makes it more costly.

In this blog, we have also discussed hedging the unknown by looking hard at the worst thing that can happen. It is fine to go ahead if you can live with that outcome, but many people can’t handle the unknowns in a decision without evaluating a worst-case first.

SILENT COST 5: OPERATING COSTS AND INSURANCE

These issues are prosaic, but you must know about them before moving forward.

SILENT COST 6: SOMETIMES YOU ARE YOUR ENEMY

I love new cars. I did not actually drool on any new vehicles when shopping, but it was close.

And that is a problem. Sometimes, you want something so badly that your desires override your common sense. And the silent costs and the analysis of the pros and cons go right out the window.

SILENT COST 7: OPPORTUNITY COST

If you make a decision, it often comes at the expense of other options. See here.

For instance, instead of buying a car about a year ago, what if we had used the same amount of money to buy Nvidia stock?

If we had, we could now buy two cars. And we could have thrown in a new subcontract, too.

I hate it when that happens. But it is impossible to predict the future. There is an opportunity cost to everything.

In the case of the Financial Samurai, the opportunity cost of his new house purchase was the loss of some of his passive income.

CONCLUSION

Decision-making is often tricky. But most of your decisions will work out well if you analyze the before and after, consider the effect of time, and consider silent costs.

Disclaimer: consult with a financial fiduciary before taking any steps outlined here. Not all advice may be suitable for your circumstances or investment style.

Image: Dietmar Becker

License: Unsplash