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After 24 years of guiding clients through financial challenges, one couple floored me with this statement: “I think we’re doing the right things with money, but we feel suboptimized.”
Suboptimized: It’s a rare word. I wondered about the obstacles that create what I call “dollar drag,” in which the highest and best use of our money is overlooked or ignored.
Suboptimization is an equal opportunity offender. We all are afflicted, even if our track record of handling money is better than average. We create mental walls that prevent us from considering how each dollar can flow freely and land at the best destinations on our household balance sheets.
Take this 40-something couple: Ambitious savers who set aside 20% of income for retirement, they had well-funded 529 plans for young children and were saddled with dangerous credit card debt levels due to a failed real estate venture.
Overall, I give them high marks when it comes to handing their money. But a simple solution to reduce the high-interest debt was clearly in front of them, and they couldn’t see it. There was a mental barrier between the personal and business debt, even though they were the business. In other words, the burdensome interest charges affected their household net worth.
Dan Ariely, a professor of behavioral economics at Duke University and New York Times best-selling author, helped me understand how to position “highest and best use” in my mind. He said: “Every financial decision has an opportunity cost. You cannot make the best money choices in a vacuum.”
You must fully consider each decision and control where your money lands.
So, how can you make better financial choices?
1. Break it down and look around.
Don’t perceive every financial challenge as a straight edge with a beginning and a conclusion. When presented with a financial decision, break down the walls, goals and compartments and picture how all your money can flow freely from different accounts and work to achieve the greatest impact on your bottom line.
When performing this exercise with my fiscally responsible couple, we concluded that using an existing home equity line of credit at less than 4% interest to pay off the credit card with 21% interest rate was the optimal conclusion. It was a major improvement they had never considered because of the mental barriers between business and personal accounts. Once those barriers were removed, a solution was obvious.
2. Grab every opportunity to assess the opportunity (cost).
I now examine the “full circle” of every money choice. I’m obsessed with dollar drag.
During a recent evening out, before ordering at an iconic Texas barbecue place, I stepped back and thought of what else I could do with the money. Was this the “highest and best use” of my 28 bucks? I took away the walls and permitted the money to flow through other options. I had to weigh the opportunity cost until I either returned full circle to the current choice or found a better solution.
This type of exercise will allow you to pause before making a purchase and create awareness about other options that may bring greater satisfaction and value.
3. Think rooftop, not basement.
When you bust down the walls between accounts, you begin to think bigger and smarter. You’re up on the roof looking over the landscape of your finances.
Most of the time, we rummage in the basement where it’s dark and narrow because of our laser focus on the problem. Unfortunately, the longer we concentrate, the less we observe lucrative options hiding in plain sight. That’s why financial decisions should begin from a holistic perspective (the roof) and then narrow down to specific issues at hand (the basement).
For example, when gasoline prices were near $4 a gallon, I was inundated with inquiries about trading in paid-off automobiles for new gas-efficient options. In other words, I was being asked whether spending $32,000 was worth saving $600 a year at the gas pump. The numbers didn’t work out advantageously. Once you consider the opportunity cost of spending five figures, well, you’re on the roof and seeing things from a clearer perspective.
4. All accounts are retirement accounts.
A majority of people have a retirement strategy. It exists in their heads but not in writing. Because written plans take into account your entire financial picture they direct you to focus on the big picture. Eventually, emotional walls fall, and you can think full circle and assess how every decision made today affects your retirement start date.
Now that you’re in the mood to bust boundaries around money, consider that any account can be a retirement account. Just because it’s not held with your employer or doesn’t have “IRA” in the title doesn’t mean the money you save can’t be applied to retirement. Society has encouraged mental accounting by separating retirement vs. non-retirement accounts.
Consider all money in one pool. You decide how it flows to its most honorable (and hopefully lucrative) conclusion.