It’s been a great pleasure to reconnect with some Connecticut clients this past week, as we have had the opportunity to conspire together about building their financial fortress, with the “new” tax law in mind.
There are still plenty of provisions within these new tax regulations for which the IRS has not yet issued clear guidance, but that doesn’t mean that we can’t make some very solid plans for people like you to implement — all so that we do NOT have to play catch-up next year during tax preparation time.
Meeting with these clients has reminded me about how so many of our financial decisions are driven by *how* we think about money. And, obviously, this subject could be the basis for an entire education, but I thought I might offer you some basic tricks I’ve used to fool my brain into thinking properly about money.
Because the fact is that our instincts are NOT always correct when it comes to how we think about and spend our money.
That’s why these principles on how to think about money might be useful to you. Let me know.
Emelia Mensa EA, CPA’s Four Tips On How To Think About Money
“I am not a product of my circumstances. I am a product of my decisions.” – Stephen Covey
It’s still a bit of a mystery why we make some of the decisions that we make.
And that’s especially true when it comes to finances.
If you have ever read Thinking, Fast and Slow by Daniel Kahneman (who, along with Amos Tversky, has been credited with being the father of modern behavioral economics), then you know how easily we can be fooled by our assumptions, fears and false intuitions.
Which is why it’s useful to put some basic principles into practice when we make decisions about money. This is besides, of course, the regular practices of following a budget, saving, investing and avoiding most kinds of debt.
These are some of the principles that you should be thinking about when you are creating that budget or making the decisions about those investments and savings plans.
Here are four principles I’ve used, and which I commend to you…
1) Opportunity costs
What do you need to give up in order to get something you want? It’s almost always a question of money, but also one that involves time and value.
Pursuing an advanced degree may take years — are you willing to put in that amount of time? Will a sports car give you enough enjoyment to offset going into debt for it?
Whatever decision you end up making about how you are investing your money, should also be applied to how you think about your time. Sometimes it really does pay to invest in a lawn care service so that you can free yourself up to do more “valuable” work on behalf of your family.
2) Sunk costs
This is money you can’t get back — a non-refundable airline ticket, for example. The idea here is that you need to keep sunk costs in the proper perspective. It’s easy to start thinking, “Well, I’ve already spent $100, so what’s another $25?” You’ve got to be willing to walk away sometimes.
Once something is paid for, and cannot be refunded, it shouldn’t impact your future financial decisions. It is a “sunk” cost, i.e., water under the bridge, and whatever you do in the future won’t ever get it back.
3) Quick Interest Calculations: The Rule of 72
Want to double your holdings? The Rule of 72 can tell you how long it will take, based on the specific interest rate. Just divide 72 by the interest rate.
For example, if you’re looking at an investment with an interest rate of 6 percent, then 72 divided by 6 gets you an answer of 12 years.
This is a rough estimate, of course, but it’s pretty effective.
In fact, you can also turn the equation around to determine the interest rate you’re looking at if someone promises to double your returns in a set amount of time. Twice as much money in 12 years? Divide 72 by 12 and you get an interest rate of 6 percent. This rule lets you evaluate investment opportunities quickly and decide where to put your money.
4) The time value of money
According to this principle, a dollar you receive today is worth more than a dollar you’ll get tomorrow. You’ll have opportunity to invest that dollar immediately and begin earning more revenue from it (and also avoid losing value because of inflation).
Again, this helps you make certain calls about your purchases — and your income. It’s the old “a bird in the hand” theory in action for your wallet.
These four principles have served me well over the years.
Are there any that you think I have missed? Do you have questions? I’d love to hear from you, so shoot me an email through the email button at the top of the page with your thoughts.
Until next time.
Emelia Mensa EA, CPA
Emelia Mensa CPA