Sure, we would all love to have the newest, largest, and most beautiful house in our neighborhood. We have to be careful, because that isn’t always in our best interest. We must be cognizant that the money our house costs doesn’t stop when we sign the mortgage. Yes, we must be certain that we have only committed to a mortgage that we can comfortably afford to make the monthly payments on, but there is more for us to consider when we choose a home to purchase. Buying a very large house will mean that we can expect to consistently pay more in taxes, maintenance, and utilities. Carefully consider everything purchasing the house will cost your monthly budget and make sure you aren’t overextending yourself to buy a house that is beyond what you and your family need.
Have an emergency savings fund
We all know that it is crucial to set aside funds that can be available if you need them in case of an emergency, but most people simply do not save enough. As a rule of thumb, your emergency savings account should:
- Contain six months’ worth of your income-if you or another member of your family would become sick and be unable to work or lose their job, you might need it;
- Only be used for real emergencies and be replenished as quickly as possible if you have to use it;
- Increase accordingly if your income and expenses increase.
Along the same line of thinking, it could also prove very beneficial to purchase long-term disability insurance. This can help you afford your current expenses such as your mortgage, even in the event that you become very ill and are unable to continue earning your full salary. Check to see if your employer offers this type of insurance as part of your employment benefits. You would have to pay for the coverage, but it would be cheaper to purchase it as part of a group than it would be to have to purchase a policy completely on your own. You should plan to purchase a policy that would cover your expenses for a minimum of two years.
If you have small children, make a will
In addition to ensuring that your finances will go toward the care of your children, having a will allows you to name a guardian for your children in the event of your death. These are choices you would not want to entrust to anyone else.
Have life insurance, especially if you have young children
No one likes to consider the worst-case scenario of something happening to us where we wouldn’t be around to care for our families. Sadly, those things do happen. You must prepare ahead of time so that your family can cover expenses if you die unexpectedly. Be sure that you have purchased enough life insurance to cover not only funeral expenses, but also the long-term expenses like property taxes, the mortgage, insurance, and car loan payments. You will want to continue to protect your family and secure their finances even after death, and having an adequate life insurance policy can help you do that. Be sure to do your homework and research the policies available to you so that you can get one that will meet your family’s needs.
Don’t forget the law of shopping relativity
Would you buy a dress for $100? (Let’s assume that you are a regular mortal being with an average salary like most of us.) My guess is you probably wouldn’t. Now, what would you do if you saw the same price for the dress, but it was discounted from $250? You would save $150! Chances are that you would take the dress off the shelf in this case. We enjoy this sweet deception, our irrational rationalization about what a bargain we are about to make. We like being deceived by vendors and manipulated. We need it, to be more precise, to be willing to open our wallets. And sellers know this. Thus, they play us using the psychology of pricing.
Humans can’t assess value unless they can compare something with something. And even so, very often they assess value in a way that it has little to do with value; as we saw in the example with the dress. Relativity plays a key role in our flawed value assessment. In the case of the dress, we assessed value based upon the relative value of the full-priced dress compared to the discounted price. The store helped us to make our much-needed comparison right on the spot. We got bamboozled by the amazing relative price of the dress.
If we were truly logical creatures, there wouldn’t make a difference which price tag we saw; $100 is $100, discounted or not. But it matters and happens to us very frequently, even if we understand the cost of relativity.
Comparing items to assess their relative value is not a bad thing in and of itself. The problem starts when we neglect the opportunity cost. Because when we compare our product, we compare it with only one thing. In the dress’ case, $100 is cheaper than $250, true. But what about $100 compared to $0? Or what about the other things we could buy for $100? We rarely think about these when in a shopping frenzy, right? Let’s take a look at the biggest relativity traps we willingly walk into day after day. When we are at the airport, we buy a bottle of water for $5 when we know that in the supermarket we could buy the same thing for $1. Or when we are at a restaurant, bang, here you go, $7 Coke. But when our plane ticket cost $800 and our dinner $150, $5 or $7 dollars don’t seem to make a huge difference. Would you buy a coke for $7 in Safeway? Now let’s imagine you’re buying a car for $30,000. The dealership offers you a CD player for just $300. Will you take it? Does the price $30,000 and $30,300 live in a different brain region? Nope. Since you are about to spend $30,000 who cares about an extra $300? Would you by the same $300 CD player by itself? Like, ever?
There is another reason why betting on our relative value assessment is such a great tactic for vendors. They make us feel smart. When we buy the dress for $150 less than its original price, we think we made a smart decision. We think we abused the vendor by snatching the dress away while it’s underpriced. We focus on the $150 saving, when we should focus on the $100 spent. We didn’t save anything. We spent $100. Now, you may agree with me, but remark that these are big expenses. You wouldn’t fall into the trap of relativity with smaller amounts. Okay. Let’s test it.
Let’s say you want to buy a computer game that costs $50. Before you go to the store to buy it, you see that at another store the same game is discounted by 20%, now costing only $40. But this store is 10 minutes farther away than the store where the game is $50. If you are like most people, you’d still make the effort to go to get the game from the store where it costs $40. You get your game, but you realize that it is not compatible with your PlayStation. Now you start browsing for PlayStations. You find one for $550 dollars relatively close to your home. When you get to the store, another shopper informs you that in a store just 10 minutes away, you can get the same PlayStation for $540. Would you walk 10 more minutes just to get the PlayStation for $540 instead of $550? If you are like more people, you wouldn’t. It is the same $10 savings. So what happened here?
This example proves that we hardly ever assess the absolute value of things: $10 for ten minutes of walking doesn’t always equal $10 for ten minutes of walking as it should. Instead we compare the $10 to $50 and $550. When we hit the obstacle of relativity, we usually make quick decisions about expensive purchases and slow decisions about cheap purchases. Why? Because all we think about is the relative percentage of our saving, not the actual amount.
Becoming more aware of our flawed value assessment and consciously reminding ourselves about the trap of relative value assessment can help us make wiser financial decisions. We need to acknowledge that when we make decisions facing a discounted item, that doesn’t make us smarter, but more stupid. The decision-making process got dumbed down for us, giving us a pre-made comparison and fostering our conscious mind from making a decision in our best interest. Keep this in mind and next time: before buying something, compare its actual price to $0 and to at least five other things you could be buying instead of that product, especially if the shopping urge rose suddenly and you didn’t need the product in question five minutes ago.
