Chapter Five
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Aside from that, stop caring about the math, kind of.
You will find a general theme throughout this book and that is, you really should be empowering yourself to advance your financial position. We have explored why behaviour will generally win above understanding the math, why professional advice is better than no advice (action is better than inaction), and we have explored the math concepts that need to be understood to properly understand the potential of your current and future day-to-day decisions.
I wanted to dedicate a brief chapter of this book to reinforce the idea that you should really stop caring about the math. Now, based on the chapter’s title, you will get the hint that the math does matter. Over time the difference between a 7% interest rate and a 6% interest rate on a compounding basis will provide significantly different results. But just like a sport or where you learn the basics and then learn more advanced techniques we want to do the same with our personal finance skills.
Start with the basics and then we can move on to more advanced items. Confusing ourselves with the math behind everything will make us suffer from a concept known as ‘Analysis paralysis’, that is - not taking action because there are too many variables, or options, available.
I once watched a presentation given by a researcher, she researched how choice can impact our decisions. I cannot remember who it was, or the exact specifics of the study but I do remember the general result. If anyone knows who this was, please contact me as I would love to reference the exact study, use the actual data, and give her credit.
The study involved going into grocery stores and setting up a table with items. On the first days, they had a small number of items, say 3; and, on the last few days they had a larger number of items, say 20. Everyone loves choice; so we think, however, what the researchers quickly discovered is that the table that had 20 items the consumers were more likely to not choose anything at all. But, nearly everyone picked an item on the table with only 3 options.
My point in referencing this, is that this concept does not just exist in stores but with financial products and the math behind them as well. With the endless amount of financial products and byproducts of those products being offered it is nearly impossible for a consumer to make a choice.
As humans we always know we are making the best decision for ourselves, at the time of making the decision. But, of course hindsight sometimes tells us otherwise.
But, what if there are too many choices, and too many voices telling us opposing views? Well - it is impossible to make the right decision then.
This is why I recommend working with a professional.
Interest rates are cool, but not important
One of the most frequent discussions I have with clients and other professionals is regarding interest rates and how they impact people. I am here to say that interest rates are, for a beginner, entirely useless. What is more important is a focus on cash flow, which we will be covering in Chapter 7.
I see it all the time. People come in with some credit card debt with the line, ‘If only I wasn’t paying 20% interest I would be able to pay this off’. It is true that a lower interest rate would allow them to pay a reduced interest amount but what if the reason why they accumulated the debt was not solved? They would still be in a troubled position as they now have a lower payment, but may still have an issue that will cause them now to increase their debt load.
I see this type of behaviour all the time. I believe that 80% of my job is to address what caused the debt issue, assist them in solving it, and then we can assist in restructuring the debt. Until the underlying problem is solved, the client won’t get anywhere.
Determine what makes you struggle. Only when you do this can you make headway in improving yourself.
Investing returns mean nothing if you are not invested
You will see many books talk about looking for returns, and investing in the ‘right’, or ‘cheap’ investments. I am going to go against the crowd and say it really doesn’t matter where you invest your money. You could have an opportunity investment that could pay you 15% a year but if you are not invested in it, you won’t make anything. People spend so much time analyzing their decisions which leads them nowhere.
If you are not invested you are not getting anywhere. If you are not saving, you are not accumulating savings. Thinking about investing or saving won’t make you save.
Actually saving, and actually investing will allow you to begin saving and investing. I know this sounds elementary but the problem is that most people simply dream without taking action. What I want you to do is dream AND take action. Take the steps to achieve what you want. In this book we are focusing on finances, however, you can apply this next technique to anything.
It is simple.
Step 1. Write down what you want to achieve.
Step 2. Write out every step that you need to achieve this. Start from the basics.
Step 3. Start checking off the items until the list is complete.
So for example: Let’s tackle a savings plan.
Step 1: Goal - I want to save $1000 in one year.
Step 2: Steps:
[ ] Calculate how much I need to save in a month.
[ ] Review bank statements to determine expenses.
[ ] Draft a budget.
[ ] Determine if I can afford monthly savings amount.
[ ] If not, how much does my budget allow for? Revise goal.
[ ] Open up savings account somewhere other than my main bank so I am less likely to use it.
[ ] Setup pre-authorized debit/automatic transfer to my new account.
Step 3: Start checking off the items as you complete them. You could probably do the first 5 steps in a couple of hours.
This list assumes you know the steps involved, however, what if you don’t know the steps? Easy! Make your step to talk to a financial adviser. Ask them questions and have them write out the steps you need to take positive action on your goals.
I apologize for this being slightly off topic but the point is to have you take action on your goals. A great takeaway from this book is simply to put your plan into motion.
We are conditioned to make decisions based upon interest rates.
We are so conditioned to think about interest rates. Think about it; when buying a car, applying for a mortgage, getting a loan, etc. What is always advertised? It is almost always the interest rate. Is the interest rate really the most important part? Of course not! There are so many other items you need to consider when actually making a purchase. I have seen so many people lock themselves into crazy low-interest mortgages with massively high penalties when they need to break their mortgages, or people getting stuck with crazy high monthly payments but with a low interest rate. Or, they bought a car worth $18,000 but were upsold $5000 of warranty packages and needless upgrades.
We will break things down in further chapters of the book but just note that salespeople always have an angle. Because of the way interest rates are always advertised to us, we will certainly focus on them. So when making decisions think about your short & long-term goals and determine how your current decision fits into that plan.
Is one of your goals to save for retirement, and you have determined that to achieve this you need to save $400 p/m? Imagine your car is having problems and you think that it is cheaper to buy a new car rather than fix the old one. Fixing the current car would cost $3,000 or you can finance a brand new one for only $400 p/m @ 0% for 7 years. Obviously, written out, putting the money into fixing your car makes a lot of sense.
But in the moment, most people would buy a new vehicle. They would think they got a great deal by having an interest rate of 0%. They would have stopped their retirement plans for 7 years AND paid for an entirely new vehicle. The worst part is the new vehicle still needs maintenance. No getting away from that!
You also see this with some loans. The interest rate might be 10% but the loan has a fee of $1000. At the end of the day whether they call it interest or a fee both are a cost of borrowing money.
To summarize: Math is important, but it is not important as the behaviour and you should focus on changing your behaviours rather than trying to find the ‘best’ solution.
Exercise – Think about the ideas that you believe are true compared to what is written in this chapter. Have you fallen victim to some of these issues?