Personal finance is often a “numbers game.” A person can sit down with a calculator and a piece of paper or with a spreadsheet and go through countless models and ideas about their financial future and, for the vast majority of those ideas, come up with some reasonable conclusions.
For example, if you’re paying off debts, you’re always going to end up paying the least total amount overall if you make all of your extra payments on the debt with the highest interest rate.
If you’re investing for the very long term future, the investment with the highest historical average annual return is probably the one that’s going to give you the best return over that very long time period.
These types of ideas (and many like them) are pretty easy to calculate if you have a bit of time and a bit of a head for numbers.
The problem is that they don’t take into account the uncertainty of the future, at least not in any reliable way.
No one knows what the future will hold. No one knows what the stock market will do. No one knows what the economy will do.
Most of all, no one really knows what’s in their own personal future.
I often look at a person’s future, at least in terms of personal finance, in terms of potential weak points. How many aspects of their life are “weak,” in the sense that they add another potential point of failure that could cause that person to encounter unexpected and significant financial difficulties?
For example, having children (or dependents of any kind) is a financial weak point. Dependents by default require financial resources without contributing financial resources in return, and sometimes their cost can spike.
Having an unstable job is a weak point. A job where you have a significant likelihood of being let go is a direct route to financial instability.
Poor health is a weak point. If you have poor physical or mental health that may lead to a condition that can disrupt your ability to earn an income, that’s definitely a weak point.
Simply being older is a weak point. Not only is your long term investment window inherently shorter, many of the other risks listed here are a little more likely and a little more devastating.
Not having an emergency fund is a weak point. It means that smaller emergencies have a much easier chance of snowballing into a big crisis in your life.
Living a paycheck to paycheck lifestyle is definitely a weak point. Although this one is definitely correctable, a lifestyle where all of your cash goes into your checking account and then right out of it without contributing to investments or significantly paying down debt puts you on a tightrope that’s easy to fall off of. This is particularly true if you’re living that lifestyle while mostly just keeping the bills paid.
Having an unreliable social network is a weak point. If you don’t have friends and family you can turn to in a crisis, that crisis is likely to amplify.
Not having a lot of marketable skills is a weak point. Marketable skills enable you to quickly find a good paying job if you lose your current one. Not having a good set of marketable skills means that it might not be easy to find another job and, even if you do, it probably won’t be comparable to your older one.
There are many other smaller weak points as well. Things like having an unreliable car or having people who are partially dependent on you can easily turn into a major issue in the right situation, though it’s usually not a crisis.
Having a lot of “weak points” can absolutely change the optimal financial choice before you.
For example, let’s look at that old dilemma of contributing more to retirement versus making big extra debt payments. Which one is better?
My argument is that the fewer weak points that a person has in their life, the better off they are investing in retirement, and the more weak points they have, the better off they are paying off that debt early.
Why? Investing for retirement is a long term investment that works best when you’re more certain of long term stability. The more weak points you have, the more likely it is that serious instability is going to hit your life before retirement savings can really pay off. Remember, most good investments are long term investments, and if a weak point breaks in the short term, there’s a good chance that you’ve lost money by investing for retirement.
On the other hand, paying down that debt is better in the short term because it moves you quickly to a point where you no longer have those debt payments. You can quickly eliminate smaller debts if you really focus on them, and that gives you some life flexibility because you’re much farther away from living paycheck to paycheck. The “weak point” of your job or an illness or something like that has a lot less impact on your life if you’ve got your debts under control and some healthy breathing room in your monthly budget, and paying off debt is a very strong route to that point.
So, if you’re a single twentysomething with no children and great health and you use mass transit to get to work and you have a bunch of marketable skills in a stable career path, you’re better off saving for retirement over paying off every single debt.
On the other hand, if you’re in your forties, married, with kids, with a job that might not be as stable as you like, perhaps without as much health as you’d like, and without a hot resume in a hot field, you’re probably better off getting rid of those debts as soon as possible.
Now, this isn’t a perfect dichotomy. The person in their twenties should probably get rid of really high interest debt first by eliminating the credit card debt and any payday loan debt. Similarly, the person in their forties should be making sure that they’re contributing a little to retirement, at least enough to get every drop of matching contributions from their employer and ideally contributing at least 10% of their salary.
However, beyond those basics, the person with fewer weak points should probably accelerate retirement and the person with more weak points should probably accelerate debt repayment.
It’s always useful to consider the stability of your life when making financial decisions. The more weak points you have, the more valuable it becomes to stabilize your day-to-day situation. The fewer weak points you have, the more valuable it becomes to do things that have big long term benefits. That basic principle will always help guide you toward better decisions.