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How To Make Better Financial Decisions

Decisions! Decisions! You and I face numerous financial decisions every day. They range from the trivial: should we order UberEats tonight? to the more substantial: how much do we spend on our home? However, the total sum of all these decisions, year-on-year, determines our financial situation.

Decisions! Decisions! You and I face numerous financial decisions every day.

They range from the trivial: should we order UberEats tonight?

to the more substantial: how much do we spend on our home?

However, the total sum of all these decisions, year-on-year, determines our financial situation.

Psychologist and Nobel prize winner Daniel Kahneman explains in his book ‘Thinking, Fast and Slow’, we have two systems of thinking. "System 1" is fast, instinctive, and emotional, while "System 2" is slower, deliberate, and logical.

I’ll tell you straight up, from my own experience – emotions aren’t the best financial decision-making tools.

Have you ever asked yourself “what’s my decision-making process?” and if you’re in a relationship, "how do we make financial decisions together?"  

The secret to making better financial decisions is using your System 2 thinking. We need to override the quick-responding, emotional and impulsive pull that we’re all hard-wired to go to and shift from System 1 to System 2.

Here are 5 practical steps to work with, not against, that clever brain of yours:

1.    Delay the purchase/ investment/ decision

Give yourself time and space to switch into your System 2 – your rational and logical thinking.

Ask yourself “what are the drivers and motivation behind this decision? “

"Is it a want or a need?”

“Is this decision taking me closer to or further away from my long-term goals?”

If you don’t have financial and life goals, STOP – write these out before starting these 5 steps.

2.    Catastrophise possible outcomes

Write a list of all the things that could go wrong, or be detrimental to your long-term financial position as a result of this decision.

Look beyond the obvious and if everything seems positive, then you’re probably stuck in System 1 and you need more time to evaluate this.

3.    Consider your current financial resources then evaluate the potential opportunity costs

For example, if you’re allocating money to this financial decision, what will you potentially miss out on in the future? (these are your opportunity costs).

Ask yourself, what could this decision cost you in other areas of your life or finances?

4.    Collect the facts and figures and explore your options

Before making a decision, make sure you’ve done your research – learn what you need to know. Consider several options, substitutes, and alternative courses of action in this step. Evaluate factors such as costs, and that’s total costs, benefits, risks, and implications.

Your end decision is only as good as the facts and research you used to make it. Make sure that your information is trustworthy, and that you've done your best not to just seek out data that supports your decision – look for alternative data. This will help you avoid confirmation bias, a common psychological partiality in decision-making.

Be careful here in this step as too much information can leave some people paralyzed with uncertainty and cause indecision.

5.     Opinion-shop your decision with others

Talk about your decision-making process with someone you trust and respect, but who also doesn't always agree with you and isn’t afraid to tell you. This step serves two purposes:

1.    Explaining how you’ve arrived at your decision shows that you’re on top of what you’ve researched and understand it well.

2.    If you’ve selected the right person, they can offer a different view as they are not emotionally invested in the decision.

This step can highlight flaws in your thinking and discover different perspectives that will either argue or support your conclusion.

Obviously, these decision-making steps aren’t appropriate to use when you’re walking down the aisle to buy your breakfast cereal but do apply to decisions like making an investment, purchasing a car, reviewing your super fund, or setting your budget.

Being present, aware, and using our ‘System 2 thinking’ when financial decision-making
leads to better financial outcomes.

Warmest,

Karen Eley is a financial coach with more than 20 years’ experience as a financial adviser. Through her business, Women Talking Finance, she helps women to be confident and knowledgeable about all things finance. Karen translates complex financial concepts into simple digestible ideas.

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