This is a guest post from Darwin of Darwin’s Finance. If you like what you see here, please consider subscribing to his RSS Feed.
In life, we’re routinely faced with situations that require an immediate reaction. Consider the need to pay monthly bills and keep your head above water. Beyond these short-term reactions lie proactive decisions that provide longer-term benefits.
For example, paying yourself first with just $50 extra per month to go directly into an IRA, 401(k), or other account is a proactive step that will lead to a better retirement. While such thinking results in obvious benefits, however, it typically requires delayed gratification.
With budgets becoming increasingly tight for Americans, being proactive in just a few facets of your financial decision-making can provide you with enormous benefits and set yourself up for long-term financial success.
I’ve highlighted below a few situations in which it pays to be proactive rather than reactive. If you find yourself constantly reacting to financial situations, you may want to ask yourself why, and whether it’s time to get a little more proactive.
Emergency savings
Having an emergency fund prevents painful emergency fees, payday loans, credit card interest payments, and other non-essential payments that you wouldn’t otherwise incur. Nobody sets out in life saying, “I’m looking to pay exorbitant fees on debt for the rest of my life,” but that’s the situation many people find themselves in without proper planning.
Life happens, and the repercussions of living without a safety net can last for years. You risk bankruptcy or foreclosure, or at least being forced to sell off personal assets at a loss to make ends meet.
If nothing else, having cash to fall back on will help you sleep better at night and should outweigh the perceived benefits of owning a high-end car or the latest HDTV technology. If you don’t have an emergency fund, think about what it would take to build one. The near-term sacrifices will be worth it in the long-term.
Budgeting
Living paycheck-to-paycheck carries thousands of dollars per year in hidden costs. Without sufficient cash on hand, you lose out on things like early payment discounts on taxes, insurance, etc. You’ll also wind up facing unnecessary overdraft fees when your accounting is off by as little as $1. Beyond this, you’ll be unable to take advantage of one-time opportunities where having cash on hand can save you money (see below). If you can’t stand budgeting, at least consider implementing a reverse budget to avoid these problems.
One-time events
Americans have been presented with numerous one-time opportunities to exploit situations created by the financial crisis, but only those with liquid cash and/or good credit have been able to take advantage of them. Examples abound, including the homebuyer tax credit, cash for clunkers, and the opportunity to buy into the stock market when investor capitulation sent shares down by as much as 50% (70% for Emerging Markets).
An upcoming opportunity is the cash for appliances program, which is being rolled out state-by-state. This program will allow you to replace your aging appliances with a more energy efficient model at a substantial discount. You will also realized the long-term benefit of decreased energy costs.
Perhaps your existing appliance are already reaching the end of their useful life. If you combine the government’s incentive program with adequate cash on hand and a bit of research, you can realize a very strong return on your investment in 2010.
Paying for convenience
People sometimes take the easy route instead of the smart route at the expense of a few dollars here, a few dollars there. This translates into hundreds, if not thousands of dollars per year in leakage from your after-tax budget. A simple example involves buying food and drinks at the movie theater instead of taking them with you.
Here’s another example: I went to a Borders and browsed the store for books for my wife last week. I found several that I knew she’d love, but instead of just buying the books on the spot, I whipped out my iPhone and checked out the prices at Amazon. Even with the in-store “discounts” and club card, the savings at Amazon were over 30%. By planning ahead and allowing time for shipping, I saved a quick $30 on Christmas and personal book purchases.
Finally, we shop at Costco several times per year and buy in bulk instead of paying significantly more per unit at a grocery store. While shopping at Costco takes a bit more planning, and the up-front costs are higher, we save a ton of money. Surely, you encounter these sorts of situations daily. Each time you’re making a purchase, think about whether you could’ve done better with a bit of advance planning.
High ROI expenditures
Seeking out a high return-on-investment (ROI) is a smart way to improve your bottom line. There are some very simple and inexpensive ways to reduce utility expenses at home that many people don’t consider. For example, while buying conventional light bulbs is cheaper than CFL bulbs, there’s no question that you save money with CFL bulbs over the long term. Other examples include reducing your utility costs by switching to a low-flow shower head, planting shade trees around your house, and investing in an energy audit for your home.
Investment strategies
Reacting to market news by altering your investment strategies has wreaked havoc on retirement funds of millions of Americans. While Western society has hundreds of years of historical market data indicating that over long periods of time, equities outperform bonds and cash, millions of investors sold out of stocks last winter/spring, effectively locking in their losses.
They just couldn’t take the continued declines and bad news. Unfortunately, those individuals that reacted to recent market performance and deviated from a long-term investment strategy missed out on a huge rally. In contrast, investors that stayed the course are now seeing their 401(k) balances at or above the pre-crash levels (Vanguard notes that 60% of 401(k) accounts now have more money in their accounts than prior to the start of the crash).
While cynics will point out that monthly investments and company matches continued along the way, the point is that by sticking to the same long term strategy, these 60% are in pretty good shape compared to those who panicked and reacted to poor market performance by jumping ship.
No responsible investment adviser would advocate 0% equities in a retirement account with a 20+ year time horizon, but I have colleagues and friends in their 30s who completely sold out of stocks earlier this year and said they’re never coming back. Their investment portfolios will almost certainly lag behind inflation, meaning their money will be shrinking.
Closing thoughts
As you can see, there are many situations in which we’ll be forced to react if we haven’t gone to the trouble of planning for the future. Yes, being proactive and planning ahead requires short-term sacrifices, but the long-term benefits make it all worthwhile.
Do you have additional examples of being proactive vs. reactive in your financial life? If so, please share them in the comments.
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