Know your current financial situation.
What resources are flowing into your financial system (…salary, pension, Social Security, etc.) and what is flowing out (…in the forms of spending, taxes, and savings)? What do you own (assets) and what do you owe (liabilities)? This basic knowledge is key to creating a viable financial plan, and to effectively addressing and responding to the inevitable changes that come with time…and with the unexpected.
Know financial fundamentals.
While you don’t have to be a financial guru, knowing and understanding relevant basic financial concepts on some level is essential to making informed decisions. Deciding on a retirement date without understanding the “time value of money” or how a “tax-deferred” account works is like flying blind. The same holds true for investing without knowing the basic differences between a stock and a bond, or not understanding concepts like “volatility,” “diversification” and “risk/reward”…at least to the degree necessary for you to be comfortable, confident, and informed in your decision-making.
Know the tradeoffs.
Every financial decision you make has potential tradeoffs…pluses and minuses…advantages and disadvantages…risks and returns. Thinking things through and being able to identify and evaluate potential outcomes is critical to informed decision-making. Taking your Social Security benefits early will have a positive impact on your current cash flow, but it can also reduce your lifetime benefits significantly. Opting for the “annuity” payout on your pension plan at retirement can provide you with “guaranteed” income, but the “lump sum” option might better address the loss of purchasing power that comes with inflation over time. Knowing the tradeoffs involved in a particular course of action, understanding how those tradeoffs apply to your unique, personal financial situation, and thoughtfully weighing potential outcomes are essential elements in making informed financial decisions.
Know what you can control and what you can’t.
Some things in your financial life you can control…and some you can’t. Understanding what is controllable, what is “somewhat” controllable, and what is not at all controllable is key to making informed financial decisions that are likely to lead to better financial outcomes. You have total control when it comes to setting realistic financial goals, how much you spend and save, and the risk you are willing to take in your investment portfolio. You have some control over how long you work and how much you earn, your longevity, the fees and costs you pay for your investments, and certain investment-related tax efficiencies. You have no control whatsoever over disruptive world events, political stalemates, the behavior of the market or market returns. Focusing your efforts on those things you can control in your financial life, while finding ways to best address those you can’t…is critical to informed decision-making.
Know yourself and your financial behaviors.
Knowing yourself and your financial behaviors is a key element in informed financial decision-making. When it comes to money-related decisions, are you impulsive or deliberate? Do you crave instant gratification or feel a sense of accomplishment in working towards a goal? Do you feel a need to “keep up with the Jones” or feel content and confident living within your means?” What is your history surrounding money? What emotions come into play when you are dealing with financial issues? What motivates you to act in certain ways around money-related issues? How likely are you able or willing to modify or overcome unproductive money behaviors? Knowing yourself and your financial behaviors can help you (…and your advisor) make more informed decisions and tailor solutions or courses of action that are more likely to be successful, as compared to ones that do not take into account your personal relationship with money.
Know what is actionable and what is not.
The best financial strategy is worthless if it can’t be practically and successfully implemented. If a course of action is too complicated to set in motion and/or sustain…if you can’t or don’t “buy into” a strategy because it doesn’t fit with your world view or your unalterable money behaviors…if you and a significant other are at odds about what actions to take, then viable alternatives must be considered. Sometimes the optimal financial solution is not necessarily the best “real life” financial solution for you. Knowing what is actionable and what is not in your financial world will help you to make better, more informed decisions.
Know your personal and financial goals.
Having clearly articulated, measurable, and attainable financial goals is key to making informed financial decisions. In fact, it is the reason making informed decisions matters in the first place. Your financial goals, and how you prioritize them, are the embodiment of what you value and care about most in life (…security, family, education, independence, freedom, fun, responsibility, etc.). Achieving these goals is your target, and each financial decision you make, big or small, will lead you closer to…or farther from…that target. Making informed financial decisions on a consistent basis…all focused on attaining your financial goals…increases the likelihood that you’ll hit a bullseye!
Debra B. Freedman Personal Financial Planning, LLC is committed to helping people make informed financial decisions for a better life!