The best way to approach money is as a constraint. This mindset will help you build wealth without causing yourself misery from deprivation. It will also keep you from over-emphasizing the weight of money on decisions you make for your life.
There are two types of people I will cover today. One group completely ignores financial consequences when making decisions. The other group does not make any major financial decision unless it will increase their wealth. Depending on any number of variables, people in either group can be wealthy – but I think they are both wrong. In fact, the average net worth of Americans indicates that in the long-run, both are ineffective and/or unsustainable for most.
Ignoring Financial Consequences
The first group of people want what they want when they want it. These types usually don’t think about how it will be paid till it is almost too late. College education is a perfect example of this. Most parents and students don’t consider upfront what they can afford; so it’s no wonder that the financial costs (debt) are devastating. Depending on your perspective, it could be a “need” or a “want”; an “asset” or an “expense”. Either way, these folks will not seriously analyze their finances unless and until they have figured out what exactly they want – by then they will accept whatever financial cost is necessary. We’ve all seen this before – and most of us have been this way at some point in our lives.
This way of thinking is dangerous because it almost never makes financial sense. For the ones who end up borrowing money the debt can be tough to deal with in the short-term. These people might earn a lot over time, but still continue to feel broke. They will always have just enough bills to reduce their cash to zero every month. I recall a Yahoo article where a man making a six-figure income talked about how small it is. “We live well,” he said, “but I wouldn’t consider it anything extravagant.” That opinion is surprisingly common among high earning people, but it is not based on fact. One hundred thousand dollars a year is more than 95% of American workers earn, so by definition it is extravagant. I wouldn’t be surprised if that man’s way of making financial decisions is part of the reason he doesn’t feel rich.
People who ignore financial consequences until the end are likely to be in debt all the time, regardless of their income level. They are also likely to never feel like they are getting ahead. You’ll find them in the headlines all the time – and on television shows with so-called “Financial Experts” trying to help them fix their finances. No matter what, I believe they’ll return to being “broke” because of how they think.
Putting Money Above All Else
On another extreme, there are people who refuse to make any decision unless they think it will increase their wealth. They won’t buy a car unless it has the best resale value. They always insist on buying a real estate property instead of renting – because of the opportunity to build equity. More than anything, they find it impossible to separate functionality from investment performance, because to them every dollar has to earn a return. These people put money first, and not surprisingly, we all envy their bank accounts.
Putting money above everything else also makes headlines. Remember the guy who paid off his student loans in a super short time? He admitted that it was an emotional decision and he was “lucky” to succeed. When these people have above average earnings, they can become millionaires very quickly. Unfortunately, most people don’t earn that much – so this worldview alone can’t help them. Putting money above all else is counter-productive because many things in life are more important. Being debt-free is never better than being happy or healthy. Thinking of money as the most important variable can cause a person to ignore important things in the short-term, and put more of their wealth at risk in the long term.
If you’re like me, you’ve been tempted to put money first. Student loans are no joke, and I’m sure they have made you rethink that Starbucks Latte you just bought. Smart people don’t want to ignore financial consequences, but money is so hard to come by that we can’t help putting it first. Everywhere you look, things are measured in financial terms – even college. What are we to do then?
The Idea of Money as a Constraint
There is a way to make decisions that always make financial sense, without creating other problems in your life. All you have to do is think of money as a constraint – nothing more, and nothing less. We already know you don’t want to ignore it nor do you want to make it your focus.
First, decide how much you want to spend on something. It doesn’t matter what you are shopping for – you should run the numbers (or ask someone to do it for you). After you thoroughly analyze your situation and figure out how much you should spend.
Second, ask yourself “what” or “which” to buy. For example, after you decide that you can only afford $200 for a vacation you can shop for the best vacation at that price. You might end up driving to a nearby bed-and-breakfast, but you will still get your time away to recharge. Even better, you’ll have no regrets about over-spending when you return. By doing this you use money as a constraint that focuses everything else you do. For example, you can buy a car because you want one, but not because it was on sale. Money allows you to buy the car, but isn’t your reason – no matter how cheap the car is, if you don’t want one you won’ buy one.
Thinking of money as a constraint is hard work. It means never saying to your children that they can have anything in the store. You have to set a constraint, and afterwards you will often find that you really can’t afford what you want to buy. You will therefore face the reality that you can either earn more money (change your constraint), or wait until you can afford better. Most importantly, you will learn discipline for more important financial decisions down the line.
The way I see it, the biggest challenge is how to set the constraint. How exactly do you know that you can only afford a $200 vacation? (Yes, I’m asking you. How DO you know?)