Handling Finances

Now that people are starting to get their tax rebates, our economy is in for some serious stimulation!  The idea is that we’re supposed to go out and buy new stuff which will keep businesses rolling along which will keep people employed.  Some might argue that we need a recession to drive inefficient companies out of business (freeing up workers and resources for better-run companies) but it’s a rather unpopular idea — especially now that our retirement savings are almost universally invested in the stock markets after years of our government giving tax breaks for 401(k) contributions.

If we step back for a moment and consider that the economy won’t totally collapse if every penny of the 100 billion is turned into profits and wages (it won’t), it will become clear that paying off debt will actually do as much or more to stimulate the economy than simply spending on consumer products.

Increasing future spending.

First of all, with every penny you pay back on your debt, you free up the monthly interest to be spent on other things.  Putting the $600 individual rebate toward debt could save as much as $150 a year in interest at an all-to-common 25% interest rate!  Today’s politicians are no-doubt counting on the stimulus today so they can take credit for the booming economy, but if we’re willing to think just a couple years out, the sustained effect of $100 billion less debt would be huge (and wouldn’t largely be wasted in profits to foreign countries).

Free up financial markets.

One of the biggest reasons for the current recessionary scare is sub-prime lending.  Sub-prime lending is hugely profitable as long as the economy is booming because lenders can charge exorbitant interest rates that more than cover defaults.  Of course, the banks book their profit each year and don’t generally set aside some of that profit to cover future defaults if the economy goes bad (or it wouldn’t be profit) so they’re stuck with huge numbers of bad loans that are no longer profitable as people become unable to repay them.

Banks don’t really want you to pay back your loan faster since they don’t earn as much interest that way, but in this case, the financial markets are so gummed up that every dollar they get back will be one more dollar they can lend out — further greasing the skids of our economy and getting everything moving again.

Ultimately, do what’s best for you!

Nobody’s trying to tell you what to do with your money, but I hate to hear people say that you should spend it or save it.  Politicians will benefit more if you spend it ASAP and make them look like they lead the economy well.  Companies worldwide will benefit more if you spend it on consumer products and a small fraction of it will go towards jobs.  The economy will benefit if loans are repaid (especially sub-prime loans) and banks will benefit if you continue to make minimum payments no matter what else you do.

In the end, look for where the money will do the most good in your personal financial situation.  While there are no strings attached, with the government running a huge yearly deficit (it doesn’t look so bad until you add in the regular “emergency was spending” to the budget), we’ll get stuck with the tab in the form of increased taxes or decreased services (say a 50% cut in social security payments?) in the long run.  While I’m a big fan of doing what’s best for my country and the world, ultimately, what keeps you self-sufficient will benefit those around you the most in the long-run.

On Wednesday, I wrote about recognizing expensive habits that can bust any budget. While recognizing habitual spending can help set priorities, recognizing how we make decisions can help us to develop good habits to begin with. Unfortunately, this isn’t as easy as it might sound.

To put it bluntly, our days fighting tigers in Africa have left us with some quirks that lead to poor decisions.  Advertisers are fully aware of these behaviors and use them extensively to affect our behaviors.

Be aware of anchors.

The first is something I find particularly fascinating — anchoring.  We don’t simply memorize every single price we’ve ever seen, instead we tend to compare similar items to determine value.  A good example of this is in restaurants where there’s a long list of similar foods for various prices.  If sales of the more expensive (and profitable) dishes are slow, lowering prices can actually hurt sales further.  Instead, increasing the price of a couple of dishes will make the rest of the food seem more reasonably priced!  Similarly, even discount stores will often prominently display expensive items along with slightly lower “sale” prices to make the sales seem even better than they are.

Similarly, when people develop anchors, they’re hard to change.  When people move from areas with low house prices (say, Iowa) to places with high prices, they tend to buy much smaller houses.  If they move from areas with high prices to low prices, they tend to pay the same amount and get much larger houses.  In moving, it’s generally a good idea to rent for a year or so to allow time to reset the anchors.  With other  items, it’s important to evaluate the actual value (i.e. will you use the item?  How often?) and consider what else that money could purchase.

Consider cost with each purchase.

Say you normally make coffee at home, but one morning you didn’t have enough time.  You purchase a small cup at the coffee shop near work, and go on with your day.  It’s just a one-time thing, right?  Probably not if you’re an average human.  You see, we’re wired to take shortcuts in our thinking and one shortcut is that we avoid making the same decision more than once.  Once you’ve bought coffee at that coffee shop, you’re much more likely to go back in a couple days — maybe even if you didn’t forget to make coffee in the morning!  To avoid this kind of habit, you have to develop the habit of considering the cost every time you make a discretionary purchase.  Don’t just assume (as we’re all prone to do) that because you have been spending at a particular coffee shop, the spending is worth the cost because it’s entirely possible (even likely) that that spending started as a “one-time thing” that you just never reconsidered.

Think before buying.

Again, it’s important to think before each purchase — even everyday purchases.  Experiments have shown that simply thinking about what else you could purchase with the same money minimizes the effect of anchors and habitual spending.  Spending some time to consider the purchase can result in odd behavior — I sometimes stand in line for a few minutes for a drink or snack before turning around and leaving when I decide the purchase isn’t worth the cost.  Still, I think that a little weirdness is well worth the saving you get from carefully thinking before buying.

What if I told you I actively choose to pay more for exactly the same product.  Would you consider me stupid?  What if I said the extra cost didn’t gain me anything like convenience or service.  Maybe I’m just impulsive?  Or maybe I’m talking about a charity auction or a deal with a good friend?

Nothing so exotic — I’m talking about soda pop and candy bars.

I know I’m addicted to sugar and salt.  Every day, I walk by a vending machine that calls out to me, “it’s soooo sweet…”  Occasionally, I even drop a few quarters into the slot to receive my little 300 calorie package of chocolaty goodness.  Some weeks (like the week after Easter) I find myself visiting the vending machine daily as my taste buds crave their fix after a week-end overdose.

Vending machines are a terrible waste of money — the conveniently placed products cost over twice as much as the same product purchased in a pack of 10, and they have to be outrageously profitable as they only need servicing every month or so.  However, I choose to let myself visit the vending machine for my sugar fixes for one simple reason — if I purchase more sugar, I will eat more sugar.

I have decent self-control.  I can wait months after saving enough for my new camera just to make sure I don’t miss saving for retirement 40 years in the future.  I’m waiting to save even more as a down payment on my mortgage even though I could easily afford to purchase a house now.  Yet when it comes to sugar, my willpower just breaks down.  That’s not to say I can’t resist excess sugar, just that the craving neither increases nor decreases — it just sits there waiting for a weak moment.  Perhaps I even have an excuse — since my wife is diabetic, I do a decent amount of cooking with Splenda, and I recently read that these non-caloric sweeteners short-circuit the signal in your brain that correlates sweetness with making you full.

Anyway, whatever excuses I come up with, the bottom line is that if I have sugar in front of me, it will be consumed.  My solution: don’t buy sugar.

Sure, I’ll visit the vending machines — sometimes much more than I should, but the simple knowledge that I’m paying so much for a bottle of sugar-water is a strong incentive to curb my intake back to once a week or so.  For a while, I tried to save money by purchasing soda in cases, but I found my spending didn’t decrease — my intake increased!  Apparently even trying all the tricks I could think of — bringing only one can to work a day (I started drinking it at home) or drinking extra water to keep my thirst down etc. couldn’t make up for the higher availability of the stuff.

Since I can’t save money by buying in bulk, I choose to continue to overpay for my pop and candy.  With a lower intake for the same cost, and with the need to actually walk across the hall and come up with dollar bills keeping the sugar just out of reach, I actually find my craving decreases over time so I do end up saving money (until Halloween anyway).  More importantly, if spending more saves me from consuming even a hundred empty calories a day (and it does), I come out healthier for the cost.

It’s not a decision I take lightly, and the high prices at vending machines do make me cringe, but the pain is what makes this strategy work in the first place.  Yes, I do make a goal to avoid vending machines some weeks (and often I even succeed) but forcing myself to pay a premium at vending machines is my first line of defense against unlimited consumption of chocolate and soda.  For once, I’m happy that vending machines charge so much, and I’m glad those evil dispensers are there to tempt me just enough to curb my sweet tooth without turning me to great deals on 5-lb bags of skittles.