Making any type of big financial decisions requires proper planning.
When it comes to these decisions, there are five main steps to take to help you make the best decision possible.
It’s important to take these steps to make an informed financial decision. Whenever a decent amount of money is required, you want to know that you looked at all of your options before throwing any money down.
If you have to make a large financial decision in your life, here are the steps you need to take to make it a confident one.
5 Steps to Take Before Making Big Financial Decisions
These steps will lead you to the most informed decision that makes financial sense for your personal situation.
Step 1: Identify your goals.
The first step to take when you make big financial decisions is to set clear financial goals.
Doing this is important because when you set goals, you can see if those financial decisions fit your plans. If the things you want fit with your financial goals and are something you can afford, you can prioritize those decisions.
If they do not, that financial choice may not be at the right time.
Having your goals listed lets you easily start to see which decisions you need to follow additional steps for.
Step 2: Gather relevant information.
The second step after identifying your goals is gathering all relevant information.
If you have to make a big financial decision that seems to align with your goal, you need to get all the necessary information before making your decision. Some information that can be helpful to know::
- The total cost
- Finance options
- Long term risks
- Long term gains
- Alternatives
Step 3: Consider your options.
Once you know all the important details about the financial decision in front of you and how it aligns with your goal, the next thing to do is consider all of your options.
You need to weigh the pros and cons of different options. With most large financial decisions, there are different options you can have.
For example, if your goal is to grow your real estate portfolio and you found a great property, you need to look at your options.
What are the pros and cons of this property, and are there other potential outcomes that could occur?
Understanding the risks and rewards can help you understand if this is a financial decision you would feel confident in making.
Step 4: Make a decision.
Steps 1, 2, and 3 are crucial to help you actually make your decision.
Once you have done your research and understand the potential risks and outcomes that can occur, you need to actually decide.
The information and options you gathered in the previous steps should make this part of the decision-making process easy.
You may have even been able to make certain decisions earlier in the process, especially if something didn’t fit with your goals or if you realized that the monthly payments would not fit with your budget.
Step 5: Evaluate your decision.
The last step when you make a large financial decision is to go back and review it.
This is an overlooked step. It can be easy to think once you decide, that’s it, but it’s good to review your decision. Once you’ve slept on this decision for a day or even a week, you may realize you need to make certain adjustments.
Depending on the large financial decision, like buying a house, you may have discovered information about the property that could change your mind.
4 Main Factors That Affect Financial Decision-Making
While it may seem easy to make a financial decision, four main factors can affect your ability to decide.
In addition, many external factors can influence your decision-making process. Awareness of these four factors can help you avoid making an impulse or a peer-pressed decision.
Factor 1: Emotional state.
Your emotions can play a huge role in how you make decisions.
For example, many people have the habit of when they are upset they spend money. Avoid making large financial decisions when experiencing any emotional state, from being extremely happy to extremely sad.
Many people usually regret the decision they made during an emotional state. Waiting a few days to cool off can save you thousands in a mistake.
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Factor 2: Cognitive biases.
Cognitive bias is when we hold a belief that may not be true, but it influences our beliefs, decisions, and values.
People not aware of cognitive bias may make financial decisions because they believe something is a good financial decision. For example, many financial scams like we see in Multi Level Marketing may seem like this business will lead us to financial success, but in fact, they may bring more financial burden.
Always look into the financial decision you are making and do your research to see if there are experts who agree with this decision.
Factor 3: Social influence.
It is very easy to be influenced by the people we are around or the accounts we follow.
It’s also easy to see something our friends are doing and to think it is a good financial option. For example, if all of your friends are buying homes, you may buy a home too. After all, if your friends are, it has to be a good option, right?
However, making decisions based on social influence can lead to poor financial choices being made.
Factor 4: Risk tolerance.
Understanding your risk tolerance is very important when making large financial decisions.
Unfortunately, many people don’t consider their risk tolerance, which can lead to a huge mistake.
While you may be able to afford the monthly payments or you may have the down payment for the thing you are deciding on, there can be risks with this decision.
Not factoring in if you can lose all of your money on this choice can cause your decision to have a very negative effect on you. (And your pockets)
Financial Decision-Making Examples
Two of the most common financial decisions people make are buying a home or investing in stocks.
For each of these things, you need to go through the five steps for making a financial decision.
Understanding how a home or investment in the stock market fits your financial goals is the first step.
For example, investing may be the right option if your goal is to grow your money. On the other hand, if you don’t have any desire to own a home or have rental properties, then a home may not be the right option.
Next, get all of the information you can.
If you want to buy a home, you must write down every detail.
- How much does the house cost?
- What is the down payment?
- What is your interest rate?
- How much will your property taxes and insurance cost?
Knowing this information can help you to see if this purchase makes financial sense. If you don’t have the money for the down payment, this may not be the right decision.
Gathering all of your options on this decision can help you as well.
For example, you may find that there is a better property that fits your budget. On the other hand, you may do some reading and find out that this isn’t the best time to buy a home.
So many options can influence your decision that may not seem obvious at first!
If you’ve done these first three steps and know you still want to buy a home, you need to let this decision sit with you for a few days or weeks.
There can be things that come up that could change your decision. For example, if you do your due diligence, you may get a home inspection and find that there are structural issues in the home.
Not jumping into that decision right away could have avoided a huge financial disaster if instead you had purchased the home too quickly.
How to Make a Large Financial Decision
When making a large financial decision, you need to apply the five steps for making financial decisions.
These steps can help you evaluate your decision and allow you to feel confident in it.
Taking the time to go through these steps will not necessarily mean you’re not going to take that step. It just means that you did your due diligence.
If you go through each step and decide that the decision is right for you, you can feel better about this decision.
Final Thoughts
Making big financial decisions can really influence your life, and certainly your financial situation.
These things need to be seriously considered, from buying a house or car to investing in stocks. There can be factors that you may not have thought about, like risks in investing or additional costs of homeownership, that could make your decision a poor financial choice.
Focus on following these five steps to help you feel confident in your decision.
Editor’s note: This article was originally published May 3 2023 and has been updated to improve reader experience.
