How to Make Better Financial Decisions

By Adopting an Opportunity Cost Mindset

I’m not here to list the 7 best ways to make better financial decisions. It’s not really necessary. And odds are, you’d probably forget most things on that list after a few days anyway.

You don’t need a checklist of 10 different things to make better financial decisions. All you need is a different “financial mindset” and the ability to ask questions with regards to the purchases you make on an everyday basis.

And that mindset can be broken down and simplified into one easy rule of thumb: “Opportunity Cost”.

What I’m going to discuss isn’t a “secret”. It’s a simple economic principle and in many ways a common-sense way of evaluating your personal finances. It’s been adapted by the likes of Warren Buffet and countless others.

And for good reason!

It helps keep you centered and helps you properly evaluate any financial decisions that come your way.

So, what is “opportunity cost”?

Oxford Languages defines opportunity cost as: “the loss of potential gain from other alternatives when one alternative is chosen”.

That definition may sound somewhat confusing, but it’s really not—once you break it down into plain English and provide some examples.

Opportunity cost is “what you would miss out on by making your current choice”. So, if you have $20 and you spend that $20 on lunch, you cannot use that same $20 to buy bitcoin.

Let’s put it another way. Let’s say you applied for two jobs that are nearly identical; one job pays $25 an hour and the other pays $30 an hour. What position should you take? We should all unanimously agree: the one that pays $30 per hour is the right choice here.

Now let’s add more variables. Let’s say that the $30 per hour position also has a 1 hour commute each way and the odds of you being promoted seem somewhat slim, since management seems to be very locked in place. The $25 per hour position is a smaller company that seems to be trending upward and you have the added benefit of being able to work from home. You’ve already built up rapport with some of the team members and management.

What is the right decision in this scenario?

There might not be an easy answer, but if this position is in a career path you want to stick with, the $25 per hour position might be the better bet here.

If it’s not your permanent career path, you might lean more towards the $30 per hour position, since it will allow you to earn more in the short term.

This is how you evaluate the opportunity costs of any financial decision. By asking questions and trying to get an aerial 360 view of the impact your decision will have on your life.

We see consumers make the wrong financial decisions all the time. In 90% of these instances, it stems from an error in properly evaluating their money and not understanding how to implement an “opportunity cost” framework.

We’ve seen countless consumers contribute to a high yield savings account, while still paying a 25% APR on their credit card debt. This is wrong in so many ways and why many consumers are always in search of a good debt relief company. Although, having money in a savings account may make you feel more at ease financially, it is not the right thing to do when you are paying an outsized amount of interest on your other obligations. This leads you to a false sense of financial security and does not make any “financial sense”.

Why does this framework help us make better decisions? The simplest reason is that it forces us to ask questions that we may overlook or ignore.

Adopting an Opportunity Cost Mindset

Opportunity cost is originally derived from a very common economic principal. It stems from the idea that any given business should allocate its resources towards that which most increases its productive capacity. Capital and resources should also go towards an industry in which said business has a competitive advantage.

So how do you apply this principal to your personal finances?

It’s pretty easy! There are 2 steps.

• Ask Questions
• Treat your money like “a business” and always allocate your resources towards your highest earning capacity.

The more questions you ask about the financial decisions you make the better you will be at adopting this practice. It might seem like such an easy and simple thing to do but it’s a tactic that is highly underutilized.

The simplest way to help you adopt this mindset is by asking questions that will allow you to make better and more informed money decisions.

Here’s an example: Let’s say you want to buy a car.

How do you treat your money as a business?

Here’s an example:

Let’s say you have a $1,000 in savings. You can either allocate that savings towards paying off credit card debt, investing in the stock market or spending on personal leisure. Depending on what’s going on in your life, there are multiple scenarios in which any of the above could be the right financial decision for you.

However, barring any personal preferences, money-wise, the best order of operations is to get rid of debt, then invest your money and then spend on leisure. That is the path of patience and what a savvy consumer would do.

If your investments are fruitful, it may produce enough of a return to pay for any leisurely expenses a year or two down the road. So, patience is key here!

The order of priority for spending from people that make good financial decisions should always be as follows:

1. Reduce your debt obligations so you pay less interest

2. Invest for the future so that you can earn a return

3. Spend on leisurely activities

Why do some people make better financial decisions than others?

Everyone has their strengths and weaknesses but the individuals that are time and time again making the wrong budgetary choices usually don’t budget at all and are much more likely to borrow money “heedlessly”. In many ways, taking out a loan can be a sure-fire way to “rob your future self”.

Consumers that outperform their peers tend to have a financial plan in place and use a monthly budget calculator to get their finances in order. They are consistent and steadfast in their spending and although they may splurge, they always try to maintain a good “medium”.

If you are simply taking out a loan because you got an advertisement for a good interest rate or to go on a vacation, then your head really isn’t in the right place. This is an all-around terrible idea.

And this is actually becoming a trend; these loans are referred to as “travel loans” or “vacation loans”.

Whenever you are borrowing money simply for “leisure” it is going to a very bad financial decision.

Psychologically speaking, borrowing money to “reward yourself” with a vacation also has the added effect of rewarding yourself for bad financial behaviors. This is a double whammy and is the exact opposite of what you want to do. It’s the hallmark of individuals that make bad financial choices.

How to Stop Making Bad Financial Decisions

Although, it’s important to make good decisions some might argue it’s even more important to avoid bad decisions. Bad decisions most often arise due to us following our desires and misguided impulses. The easiest way to stop them and stop falling into the same trap is to recognize when this is occurring. Before you make any type of purchase with a credit card or take that cash out of your wallet, take a breath and try to truly think about what you are doing. If you slow down beforehand you can stop yourself from making a lot of irrational financial decisions.

What are some of the main precursors to bad money decisions, might you ask?

Boredom – When we have too much free time on our hands, we are left alone with our base instincts and desires for too long. If we stay productive and focus on the good things in our life, we are a lot less likely to fall into this trap! Staying busy and employing gratitude within our daily lives will help eliminate a good chunk of emotional spending and bad money moves.

Emotional Spending – Emotional spending can lead some people to financial ruin. If you don’t safeguard your mental health, it’s going to be very difficult to get a grapple on emotional spending and restore your financial health. These things tend to go hand in hand, so definitely exercise caution and always make sure to take care of your mental health! Emotional spending is at its worst depending on the “state” and “mood” you’re in. So, how then do we stop it? Patience. Patience is the number 1 deterrent to stopping emotional spending. If you can exercise patience you’ll have already won half the battle.

Trying to Fill a Void Within Ourselves – Buying an endless supply of stuff won’t fill the void. Often times our perception of quality of life and happiness is based much more on expectations than anything else. Our state of wellbeing is relative. Someone with a lot less material wealth can live a much more fulfilling life than someone who appears to have it all on “paper”. Moreover, people tend to get accustomed to improvements in their quality of life within a year’s time. So, if you won the lottery, after a year, all relative newness and joy will fade and revert back to the mean. The moral of the story is, “you can’t buy happiness so stop overspending on it”.

Opportunity Cost Mindset & Framework for Decision Making

Rome wasn’t built in a day. Take your time to make small changes every single day and get yourself out of your comfort zone. Something as simple as not purchasing a $5 Frappuccino may not seem significant but any change (no matter how small) is always a move in the right direction. Change is often times scary but we all need to do our best to adapt. Implementing a small change can often times be the best way to make a small stride towards bettering your financial situation.

The way we make decisions helps form the basis of what kind of people are and the values we hold. If we can improve our decision making, we can improve ourselves. If we build upon this foundation and way of thinking little by little, where it intrinsically becomes a part of us and fundamental to our reasoning, we can not only stop making bad decisions but we can start making good decisions, in every aspect of our lives, not just our financial lives.