The 2 Deadly "P's" of Financial Decisions
CUE DRAMATIC MOVIE SCENE
There's a common scene in action thrillers that I'm sure you're familiar with.
It goes like this: the protagonist hero caught in some kind of precarious situation - on the edge of a crevice or cliff, or in a group stalemate where everyone is pointing a gun at each other. Whatever the scenario, danger is quickly approaching. If the hero doesn't act soon, they're going to be smashed/shot down/blown-up/obliterated in impressive HD and surround sound. Either that, or take a long dramatic fall into the great abyss.
Sometimes, the choice is as simple as "jump now or jump later", and the hero is simply waiting until the last moment (sometimes, for who-knows-why). At other times, the situation is complex enough that the hero is faced with many options, perhaps even a true dilemma, where no choice seems perfectly ideal but the decision with the highest likelihood of success has to be executed.
In either case, simple or complex, the hero has the need to analyze as many factors as they can and make the best decision before it's too late.
To those of us witnessing the scene from our couch, we can often identify the obvious thing to do rather quickly. And it drives us crazy. It's easy for us to yell "JUMP YOU IDIOT!" or "WHAT ARE YOU WAITING FOR?!", because we're just sitting in the comfortable confines of our own couch - not caught in the drama of the moment.
In most movies, we know how it plays out - the hero makes the right decision at the last possible second and we can stop holding our breath and start chomping down the popcorn again.
But in some movies, we witness a tragedy - the hero (or hopefully just a minor character that we don't care too deeply about) doesn't act in time and is lost.
So what does this analogy have to do with financial decisions?
THE 2 DEADLY "P's"
I've said it before, but long-term financial success is just as much about avoiding bad decisions as it is about making good decisions. And one of the worst decisions you can make is one of omission - not taking action on something that needs your attention.
It's extremely common for someone to make smart n' savvy financial decisions for most of their lives, but suffer one or two large-scale setbacks that they never fully recover from. What's painful is when these setbacks are usually the kinds of things that could have been easily avoided, but weren't, simply due to financial inaction.
In my work as a financial planner, I've observed several types of financial inaction in people's lives. However, they nearly all fall into one of two camps, which I call the two deadly "P's" - procrastination and paralysis.
And if you know either of these forces are at play in your life right now, with anything, I hope what I'm about to say becomes your call to action.
We all know how this one feels. Procrastination's monstrous grip can be difficult to loosen.
Simply put, procrastination is the tendency to put off important, less pleasurable tasks by doing something that's easier or more pleasurable. I like the way psychologist Timothy Pychyl puts it: when you procrastinate, you "give in to feel good."
To get rid of the negative feeling of dread or anxiety at an important task, we escape to immediately pleasurable things instead - like Netflix or Facebook - or we distract ourselves by engaging in other busy work that is more easily accomplishable, so that we still feel like we're getting something done.
In my mind, financial procrastination is the delay of action regarding something you know how to do, but you're just not getting it done. It's something simple, not complex. (As I write this, I'm reminded that my car registration is a month overdue...dang it. Why did I buy my car right around the Christmas holiday?).
To go off the dramatic movie scene analogy above, it's the "hurry and jump off the cliff into the cold water before the explosion happens" type of situation. You know what needs to be done, but you just keep waiting and waiting and waiting until the last second.
But what happens if you finally try to take action but too late? With financial procrastination, the result can be catastrophic. Here are a few examples:
- You know you need to save an emergency fund, but ______________ (I've heard too many responses to why this is, so if this is you, list your relevant excuse here). And then, when an emergency comes around, which it always does, you have to sell something or go into debt to stay afloat. If you own a house, car, or credit card, maybe you fall behind on payments...incurring late fees and damaging your credit score.
- You're auto insurance premium was due yesterday, and your next paycheck doesn't come in for another couple days. You don't want to pay out of savings, so you decide to wait - and get in an accident that day. Some insurance companies may have a grace period, but they're usually under no obligation to do so. You're dead meat.
- You got married, and you haven't updated the Payable-on-Death or Beneficiary designations on your bank and investment accounts. Your spouse is probably listed as the primary beneficiary, but what if you both die in the same incident? Your assets are going to go to your estate, through probate, and money is lost in the process. To the government. Eww.
- You haven't started saving and investing for retirement. If you haven't seen how the math of compound growth works and why you can't afford to wait to start your retirement savings, learn it as soon as possible.
Part of what's hard about financial procrastination is that there often isn't a set deadline. Risks are out there, but they are more like floating possibilities that could strike "someday." And they never feel like they're going to happen in the moment you think of them.
Obviously, this makes financial procrastination's potential damage insurmountable.
The need to do something when it needs to be done sounds so simple, and yet it can be oh-so-hard to stay on top of.
There's something that most people don't want to admit - that their financial success over the long-run largely hinges as much on execution as it does on strategy.
Knowing what to do is only half the battle.
It's painful to know you were supposed to do something, and then didn't, leaving yourself exposed to damage when it occurred (I'm talking about life in general here). And a financial punch to the gut is definitely included in that.
The second dangerous "P" of your finances is paralysis by analysis - or, as I like to call it, analysis paralysis.
Analysis paralysis occurs when you know what needs to be done, but not how to do it, leading to a delay in action while you try to understand the best option.
At its root, analysis paralysis is itself a form of procrastination, but I differentiate it because it involves more complex situations where there seems to be an unending amount of information to digest about a multiplicity of options.
This danger is analogous to the "pointed gun stalemate" movie scene. There are so many options and ways your situation could play out that you freeze up every time you get close to a decision. You're endlessly worried you haven't researched enough. Fear of making the wrong decision (or missing the best decision) becomes so strong that you don't make any decision at all, making yourself a sitting duck for disaster to strike upon.
I'm personally going to tell you the most common examples of analysis paralysis I see in financial planning:
- You haven't started living within your means or budgeting because you haven't made up your mind on whether you want to save money or pay down debt first. Ah, the ubiquitous beginner's question of personal finance. There is technically no "right" answer to this, but people study their brains out compiling the pros and cons of each side of the argument - and never actually start living within their means. It's the classic "I'll start when I have a plan" syndrome, which I guess all analysis paralysis is, but this is where it manifests itself in it's most basic form.
- You have a bunch of money sitting in cash because you don't know where to put it. I can't believe how many people I've met already who are killin' it with the savings habits. They're obviously in control of their cash flow, have a budget, and have made a habit of saving. Because the feel like they're "good with money", they think they're supposed to know what to do next, so they start learning about investing...and the reading never ends. Traditional or Roth IRA? 401(k) or an IRA first? Or should I fund my HSA? Or save for my next car first so I don't have to take out a car loan next time? I have seen people with $20,000 or more sitting in cash, above and beyond their emergency fund, that have just been losing out on investment growth because they couldn't choose between all the options.
- You had a child, and you still don't have life insurance. Term life or whole life? (answer almost no matter what: term life). 20-year level term? Guaranteed or renewable? Term life ladder strategy, or all at once? And the main one of course: how much coverage do I need? This one seems especially easy to procrastinate because the probability of dying young is low, and we are terrible at perceiving future emotions accurately. Also, life insurance is nauseously oversold by insurance agents. Just remember - if you die, you're leaving someone hanging out to dry. Even if you're single, your family has to take responsibility of the costs of a funeral and burial. The procrastination of life insurance is the saddest of them all, and the hardest to witness when there is a non-working spouse and/or children involved.
- Your asset allocation is set too conservatively while you're trying to understand how to set it up. What percentage of stocks to bonds? US stock or international stock? What's an "emerging market"? What are large-cap, mid-cap, and small-cap? These questions are extremely important, but if you can't figure them out fast enough you could miss out on some much needed investment returns. Did you know that from 1970-2015, missing the best 25 single days of growth in the stock market could leave you with 75% less? The point is, you can't afford to not be invested when you should be. Take a looky here:
I find that analysis paralysis in financial planning usually happens once you pass a certain threshold of knowledge. Basically, the more you know about finances, the more susceptible to it you are. You drown in information overload. And as the research shows, we are terrible at decision-making when presented with too many options. That difficulty is called the proliferation or paradox of choice.
A NEGATIVE SIDE EFFECT OF PROCRASTINATION AND PARALYSIS
Right now, some of you may be thinking, "I know that I suffer from procrastination and analysis paralysis sometimes, but I always end up taking action before it's too late. I decide on something, which is better than nothing."
If you leave decisions until the last second when procrastinating, or give up in analysis paralysis and just choose "something" because you're sick of researching for hours on end and don't feel like you're coming to a conclusion, you run the risk of making a hasty decision based more on emotion than on logic or reason.
This phenomenon can be called becoming extinct by instinct. You "go with your gut" because you have no energy to analyze and research any longer, so you go by what "feels" right. Do you really want to be making financial decisions under the context of having so little time left or being so stressed that you haven't done anything so far that you just...pull the trigger on a solution just to alleviate the anxiety?
I've seen people leave a 401(k) rollover until the last second, finally just hurrying and checking a box on the distribution form given to them by their old employer - just to find out that they now have to navigate the complicated rollover rules. I've seen people go buy the first life insurance policy their agent pitches to them because they can't imagine taking any longer than they already have to get coverage.
When you are up against a deadline to make a decision, you're going to act more out of emotion than logic. Don't put yourself there.
HOW TO OVERCOME THE TWO P's
My main purpose in saying all this is to merely make you aware of procrastination and paralysis, and invite you to think about how often you deal with them in your financial life. Assess how it has affected you in the past and how it may affect your future.
I'm not a psychologist, so I don't want to prescribe a solution to procrastination and paralysis on my own, though I've studied them extensively as I search for ways to help my clients.
So here's a quick rundown, though I invite you to read more on the psychology of inaction.
Procrastination is rooted in cycle of negative feelings. You feel bad that you've delayed, and so just the very thought of the thing you've put on the back-burner makes you feel guilty, making you turn to something else to take your mind off it.
The research says that one of the most effective things you can do is to forgive yourself for procrastinating. This eliminates the negative feeling and allows you to move forward.
Next, the research states you should acknowledge and accept that you may not ever feel like doing the task. Focus on action instead of feelings. Ignore how you feel and get moving by breaking things down into extremely small tasks and checking them off as you go, because with each measured step you'll actually increase your sense of self-esteem because you feel the progress.
(For more on procrastination, check this TED Talk, "Inside the Mind of a Master Procrastinator".)
Analysis paralysis is harder to find a solution to because you never want to take a shortcut or force a decision when you're really not ready to yet, because of the risk of choosing wrong or missing the best choice. Nevertheless, at some point the risk of delay may surpass the risk of a bad decision. So take these tips to offset analysis paralysis with a grain of salt. It comes from a Forbes article that I think lays things out well:
- Set a "drop dead" date. Determine a date after which you are really running a big risk if you're still undecided.
- Curb your curiosity. At some point, you've got to ease up on how much detail you're going in to with everything you learn. Going deeper and deeper into a fringe detail could really derail you from making a decision in any reasonable amount of time.
- Recognize that the moons will never align. You will always be able to find more information to dissect and analyze. In many cases with financial decisions, if you really find evidence later on that you chose "wrong", you can correct it later. And you're never going to go a lifetime without making a single inefficient choice. You're going to have course corrections because no one can see the future.
ANOTHER SOLUTION EXISTS
The thing about these solutions is that it that your life is constantly bombarded with things to take care of and responsibilities to fill. One option is to outsource a part of your financial management to a financial planner.
Be aware that not all financial advisors work like this - 99% (that's actually statistically speaking, not a hyperbole) earn commissions for selling products, meaning that their relationship with you revolves around whenever they can sell you something. If they only make money by managing your assets, than the focus of the relationship is bound to be just around your investments.
But if you hire a comprehensive, fee-only financial planner on an ongoing basis, it is a continuing relationship that, among other things, helps you avoid the dangers of procrastination and paralysis. A good financial planner will proactively schedule quarterly or semiannual meetings with you to review your finances, help you make major decisions, and track when important tasks need to be completed or updated. They'll reach out and remind you of certain things and keep you accountable and on-time, doing things when they need to be done. Procrastination problem - solved! Most people don't consider this value aspect of having a professional's guidance.
And, of course, they'll save you hours and hours of analysis paralysis because they're an expert and can come up with a optimized financial plan that is best for you in a more reasonable amount of time.
I don't mean for this to be a sales pitch for my services - in fact, let me directly state now that I don't think getting a financial planner is a must. It's like anything else you outsource partially or wholly: if you don't want to figure out the solution yourself due to time or lack of confidence, or if you just want assurance from someone who does it for a living, outsource it. We do it with car repairs, medical health, and our legal issues. We try to DIY it up to a point where we are over our heads our we'd rather exchange our money for reduced time and stress.
However you choose to resolve it, don't let procrastination and paralysis get the best of you, and don't ignore crucial financial decisions. You have too much to lose.