The Best Decision vs. The Financially Smart One
May 03rd, 2006 - 27 Comments
The financially smart decision isn’t always the right one. When I say this, it usually irritates engineers and economists, who love to believe that we all behave rationally. This just makes me even more gleeful, resulting in an upward spiral of doom. Seriously, I love messing with them.
Anyway, my friend told me an interesting story the other day: After graduating, he had about $12,000 of debt from college loans at a ~4% interest rate. He also had a good job and about $15,000 lying around in a money-market account. Now, because his interest rate was so low, technically the financially smart decision would be to invest that $15k and pay the minimum monthly payments on his loan, profiting off of the difference. In other words, assuming he could get a 10% return on his investment, he would make approximately 6% (i.e., 10%-6%) because his loan’s interest rate is lower than the returns he could theoretically get. Yes, I’m leaving out trading fees/taxes/risk/etc, but you get the point. If he went by the book, he should have invested the money and paid off his debt slowly.
But he didn’t do that. He paid the loan off entirely, all at once, despite my loud protests. Why? Because he hates debt. Like really, really hates it.
When I first heard this, I wanted to hit him with a bat, attach him to a long string, push him out of a plane, and then instruct the pilot do to 25 or 50 lazy loops in the sky. I would also make him wear one of those striped propeller hats, just for fun.
But I realized that he made the best decision for himself, even though it wasn’t necessarily the financially smart decision. Even though he technically should have made monthly payments, he hates having any debt and it would have been intolerable for him. (You know how certain people act badly with debt? They forget to pay it off, it makes them really uncomfortable, etc? That’s him.) His move isn’t the right move for most people, but there’s a larger point behind it: There are some things with money–e.g., having debt, lending to friends, having money sitting in our checking account–that drive us so crazy that we start doing weird things. The question is, can we recognize it? And then what do we do? My friend was smart to recognize that having debt drove him crazy, and he did something about it. It wasn’t the textbook move, but it was probably the right one.
Another friend of mine has had to borrow small amounts of money from her family a couple times in the last few years. Technically, when she paid it back, she should have calculated the time/interest rate and paid back the precise amount. Instead, she just paid back the amount plus $100. There’s more to life than interest rates.
“But Ramit,” anal calculation-loving dorks might point out, “you always talk about budgeting and making smart financial decisions. If she only owed $15 interest and she paid $100, she made a mistake. And now you’re writing an article to try to justify what she did!”
printf(“get a life dude”);
The truth is that your money decisions should (1) get you closer to being Rich and (2) make you feel increasingly confident and comfortable about what you’re doing. The minute your financial infrastructure starts making you feel oppressed is the minute you start ignoring it. No, don’t be stupid and use this as an excuse to do dumb things (“It makes me comfortable to buy this new $2000 flatscreen TV, so I’ll do it! Thanks Ramit!!!”). But if it makes you feel really happy, go ahead and hide $20 in your coat pocket for next season. If having debt absolutely, truly makes you go crazy and do stupid things, you don’t always have to go by the book.
Think big picture. What could you do today to make you less hesitant about managing your money for the long term?
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