Ramit at I Will Teach You to Be Rich has a fine post about how sometimes the Best Decisions are not the Financially Smart Decisions.
The financially smart decision isn’t always the right one. When I say this, it usually irritates engineers and economists, who love to believe that we all behave rationally.
He provides a couple of examples based on the behavior of his friends. One worked hard to pay off a low-interest debt instead of investing the money at a higher rate of return? Why? Because this friend hated debt. Another friend paid back $100 extra each time she borrowed money from family or friends.
This dichotomy — Best Decisions versus Financially Smart Decisions — reminds me of the Debt Snowball method of debt reduction I described last week in Two Approaches to Debt Elimination. Paying off your debts from smallest-balance to highest-balance doesn’t make the most sense mathematically, but for many people it is the Best Decision because psychologically it provides short term financial victories that lead to long-term financial independence.
I’m sure there are hundreds of little examples of other financial decisions that don’t make sense from a rational perspective, but which are important nonetheless.
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