The 4-Step framework to making tough financial decisions

August 11, 2023

Traditional or Roth?

Rent or own?

Pay down debt or invest?

These questions are the fuel that keeps Finance Twitter arguing with each other. These are also some of the most common questions I get. I call these the “grey area” questions.

There are some obvious answers:

Should I pay down my credit card debt at 25% interest or invest?

Please pay down your credit card debt.

But that’s not usually the question. It’s usually something like:

Should I pay my 6% mortgage down or invest?

And this is the grey area.

One of the reasons Dave Ramsey is so popular is because he takes a definitive stance. It's easier for him to say all debt is bad than to say, "It really depends. Sometimes debt can make sense. You have to evaluate the interest rate, the thing you are financing, the alternative investment, etc."

Following the gurus may work for a while but eventually, you’ll realize you made a mistake following their advice.

Or you’ll feel guilty for going against their teachings (even if it’s the right decision for you).

It’s not popular to answer these questions by saying:

“It depends”

But “It depends” is the only correct answer here.

The way I address these questions is a 4-step approach:

1) Write down the variables you know and the variables you don’t know.

2) Ask yourself what you want the answer to be.

3) Compare what you want vs. the math.

4) Create a plan and stick to it for a set time.

Let's dive in:

Write down the variables you know and the variables you don't know.

When you’re deciding between a Roth or Traditional IRA/401k, think about what you know:

  • Your current income.
  • The current tax rates.
  • Years into your career.

What you don’t know:

  • Your future income.
  • The future tax rates.
  • Years left in your career.

If you know you’re 1 year into your career and in a low tax bracket, you may favor the Roth.

If you are well into your career and in one of the top tax brackets, you may favor Traditional.

But if you’re in the middle with uncertainty if future income will increase?

Tax diversity may be the answer: Roth and Traditional. Remember you don't have to pick just one.

The importance of this first step is to make a decision based on the variables you do know, not the ones you don't.

Ask yourself what you want the answer to be

This is where emotion plays into it.

Because how you feel can play an important role.

If you have a mortgage with a 3% interest rate some people will tell you you're dumb for paying it off early. But what if you already have a healthy savings rate and you just hate debt?

The way you feel about debt is important.

I have worked with several people who understood the math. They knew paying down the mortgage quickly was the wrong math decision.

But they were so uncomfortable with debt they had trouble sleeping at night. In that case, paying off the mortgage may be best. Peace of mind is worth it.

In this step, it's time to tune into your emotions and understand where your own bias may play a role.

Compare what you want vs. the math.

There are times when emotion can be detrimental to your finances.

While paying down a low-interest mortgage isn't ideal, it's not disastrous to your finances.

But some decisions are disastrous.

If you are in the middle of a down market and feel uncomfortable watching your investments lose money, you may want to sell out of the market completely.

The math here based on historical markets will strongly discourage you from selling out and trying to time the market.

A decision like this could delay financial freedom for years. Your emotions should take a backseat here.

This is an example where discussing and working with a qualified financial professional can be worth the investment.

Before you act on emotion, evaluate the math to make an informed decision.

Write down your plan and stick to it.

Constantly changing strategy can also be detrimental to your finances.

The key to building wealth is staying consistent over decades.

But if you don’t feel confident in your decisions, you may keep changing direction.

If this is you, it may be worth it to pay someone to help you create and understand a financial plan.

When you make a decision, clarify how long you will stick to that decision.

Some decisions you should stick to for 5-10 years, and some you can re-evaluate annually.

In Summary

There are several paths to wealth.

The right strategy is the one that will keep you consistent for decades.

When you come across the “grey areas” where the math is hotly debated, don’t be afraid to go with the answer that feels better to you.

But math is important. Don’t leave it out of your decision-making.

Ignore personal finance gurus who try to make this world black and white.

Make every decision based on your situation and your unique financial goals.

And stick to the plan.

You’ll be on your way to financial freedom.