Today I am going to talk about what I think is one of the biggest financial mistakes you can make. That is making long term decisions based on short term circumstances.
What I mean by this is people making (or breaking) really long term financial commitments because of their current situation. Right now. In the moment.
A great example of this is when people are thinking of taking on a large debt, like a mortgage on a new home or a car finance package.
These are long term commitments and they could change the course of your whole financial life, yet people seem to make the decision about how much they should borrow based on their circumstances right now. They don’t give any thought to how things will be a year, five years or 10 years from now.
Let’s say you are looking for a new house. As you are looking, you get a massive end-of-year bonus at work because the company did really well and your performance was great.
Because you are riding the wave of your success, you go out any buy a bigger home than you were thinking of previously and you take on a 25% bigger mortgage than you had decided you could afford. Because you can afford it. You have just had a huge bonus.
This is total madness when you think about it. You are making a 25 year commitment based on your experience in ONE MONTH.
Human nature is to assume that this period of good fortune will last forever. “The company will do well next year and I am sure to be a top performer again, right?” Well – not always.
We all know that companies get into trouble sometimes. They might even go out of businesses. As much as it might hurt to admit it to yourself, that great year you have just had, might just be a bit of good luck.
Making decisions in this way can land people in real hot water. When people are making a commitment, they often tell themselves “it will be fine”, but will it?
It is easy to keep up with a large mortgage payment for a couple of months. After all, you have just had that big bonus.
But what about after a couple of years or decades? What about if you lost your job? How would you manage then?
This is an example of short term good fortune creating a poor long term decision. But it can also be that short term poor fortune leads people to make a bad long term choice.
For example, if you don’t get the bonus or payrise you were expecting, it can be tempting to cancel long term savings into retirement plans to ease the short term pressure.
This type of decision can be just as damaging as overcommitting yourself long term because things are good in the short term.
I write all of this now as January can be a time when people experience both of these extremes. Some people will be enjoying bonuses in January for their work last year and if that’s you – congratulations!
The key is not to let this short term cash boost cloud your long term judgement and make sure you don’t make large commitments that you can’t keep up with.
On the other hand, some people will be struggling with the cost of the holidays and might have credit card bills piling up. If that is you, it can be tempting to put your long-term plans on hold. Perhaps you stop saving into your retirement plan or investing money on a regular basis.
January is also a time when a lot of companies go out of business (having just survived through the more buoyant holiday trading period) and people start to lose their jobs.
If this is you, although it will seem really bad at the time, it is important to keep things in context and don’t make knee jerk decisions. Take some time to figure out what you are going to do next and how this fits into your long-term plan.
Things will improve (and probably sooner than you think) and then you can get your plans back on track again.
Whatever fortune the new year bring you, just be sure that when making long term decisions, you not only think about what life is like in January 2019, but also try to imagine what things could be like in January 2029 as well!