Feb 9, 2009

Hidden Flaws of Spending - Individual Specific Flaws (part I)

If money be not thy servant, it will be thy master.”

-Francis Bacon

After having emphasized the importance of savings and penned down a few lines about 'another inconvenient truth' – relationship between savings and sustainable living, I wrote a brief introduction about hidden flaws of spending. So, continuing the series, this post looks at a few individual specific spending flaws:

Individual Specific Spending Flaws

1. Hedonic Adaptation
The human drive to acquire more and more gives birth to greed. Our mad and insatiable desire for possessions - Never Enough Syndrome - is nothing but a plague afflicting mankind. We never feel satisfied and keep on looking for more and more.

But, despite rising wealth and income, why we do not feel any better off? The hedonic treadmill theory
compares the pursuit of happiness to a person on a treadmill, who has to keep working just to stay in the same place. Humans rapidly and inevitably adapt to good things by taking them for granted.

The more possessions and accomplishments we have, the more we need to boost our level of happiness. It explains the folly of pinning our hopes on a new car, a bigger house, or on any good fortune that comes our way, which gives us only a brief boost in happiness before we start to take it for granted. We tend to adapt, quickly returning to our usual level of happiness.

2. Impulsive Buying
When we buy some worthless stuff on our sudden & first impulse without much deliberation (i.e., without a second thought), it is called impulsive buying. The fact is that it is a very widespread and widely recognized phenomenon. Most of our purchases are made due to emotions and impulses and not logic and need. In my opinion, more than 50% of our entire purchases can be accounted for by impulsive buying.

That’s why Advertiser’s first goal is to appeal to our emotions before they appeal to our logical thinking side, because they know we are less defensive if they can get our emotions involved first.

Spending money on something that is really not needed can be a big drag on our money. And, it is one of the most important reasons why most people get into debt.

3. Instant Gratification
Most of us succumb to temptations despite knowing that we will regret later on. Having trouble with self control is quite human. As the adage goes, “A bird in hand is worth two in the bush”, we prefer an immediate gain to a delayed gain. For example, faced with a choice between a new T.V. now or a better and a cheaper model after one month, we go for the former, because the prospect of a cheaper and improved model in near future doesn’t has the same emotional appeal as a new T.V. today.

Similarly, we tend to avoid and postpone necessary but unpleasant tasks (for example, savings) even when this will imply more effort tomorrow, and we tend to overindulge in pleasant activities with immediate rewards and delayed costs (for example, unrestricted spending while using credit card) even though this may cause suffering or reduced utility in the future.

Immediate gratification is also one of the significant factors behind our reluctance to go for insurance on our own, even though we genuinely want to protect ourselves, because insurance means perceived immediate costs and future expected rewards.

4. Lifestyle Inflation
In the words of Joel Barnett, “A man explained inflation to his wife thus: 'When we married, you measured 36-24-36. Now you're 42-42-42. There's more of you, but you are not worth as much'.”

A joke apart, the incremental inflation – the difference between the higher inflation rates we actually face and the normal inflation rates estimated by the government – is nothing, but lifestyle inflation. It refers to lifestyle augmentation expenses as one rises up the career graph. No matter how little or how much we earn, our spending tends to match our income.

As incomes go up, so do our standards of living. It is tempting to scale up our lifestyle with every pay increase or bonus. At times comparatively low income earners have a greater capacity to save than high income earners due to expenditure rising faster than income.

The unrealistic expectations we have for lifestyle are contributing to living beyond our means. Another major factor for succumbing to lifestyle inflation is social pressure to keep up with friends, peers, or neighbors.

To be continued next month.


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