Each category of our finances is interdependent, not independent of one another. This means that every decision we make in one category really does impact the other categories, whether or not we realize it.

Examples of Financial Interdependence

How? If I were at fault in a serious automobile accident and did not have adequate insurance, I may be required to liquidate a significant amount of my investments to satisfy a judgment. The court may also decide to garnish my wages for several years, which might require me to wait much longer to retire or prohibit me from ever retiring. It may also reduce my current standard of living or increase my debt. So what does car insurance, which on the surface appears to be only a protection decision, have to do with my assets, liabilities, and cash flow? Everything!

Let’s say I’m the employee of a large corporation and I’m asking my HR director whether or not I should sign up for the company’s 401(k) retirement plan. The HR director probably would not even be allowed to ask about my mortgage payment, liquid savings, credit card debt, or taxes. However, would these questions be relevant to my decision whether to invest in a 401(k) and how much to contribute? Absolutely.

What if I only have $1,000 in liquid savings and my monthly mortgage payment is 30% of my gross monthly income? I may be better off putting the money in a liquid savings account to cover unexpected emergencies or unemployment, because I may not be able access my 401(k) for these purposes without significant penalties.

What if I have credit card debt at 18% interest and am only making the minimum payments? Then maybe I should pay off my credit card first, because I am highly unlikely to make anything close to 18% consistently on my 401(k) investments.

What if I am married with three kids, donate 10% of my income to my church, and own a home, so my itemized deductions already put me in a relatively low tax bracket? Then maxing out my 401(k) contribution just to get another tax deduction may not be the best use of my money right now. Get the idea?

Big Picture Financial Planning

When we make financial decisions with the big picture in mind and evaluate a variety of options with the help of a competent advisor to determine which one best fits our personal goals, we always can be confident that we made the best possible decision. We will be free from the anxiety that comes from other people telling us we made a mistake. We will not be subject to bias, hype, or the opinions of others.

Of course circumstances and goals change over time. Tax laws change. Markets fluctuate. These and other issues may cause us to alter our course every once in a while. However, we can still be satisfied that in the moment each decision was made, it was perfectly in line with our objectives at the time.

 

Adam Dawson, CFP® is a Principal at Capstone Capital and the author of Timeless Principles of Financial Security.

 

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