Saturday, January 30, 2010

The Rule of Small Bits

There is no wedge in the pie chart labeled "waste" - whether it is your personal life or the government budget.

 When I was running my own business, I was distressed to see that while I was working hard, and we were taking in hundreds of thousands of dollars in income, we were not making much money.

One of my employees, said, "Well, you just have to cut out the waste!"  He had a similar theory about the Federal Government - that all they needed to fix things was to "cut the waste."

Unfortunately, when I check my Quickbooks, there was no pie wedge labeled "waste" that I could just click on and delete.

What I learned, the hard way, over many years, and am still learning, is that "waste" is very hard to trim, as it comes in very small bits that are difficult to track down. Savings come not in huge chunks, but in tiny savings here and there, that when added up, save large amounts of money over time. a few dollars on the phone bill, a penny here on copy paper, 10% on your utility bill - things like that. These are difficult savings to find and implement, but they pay off. It is hard work.

For example, you may wonder why, at the gas station, there is no hot water when you wash your hands. I wondered too. Until I realized that at my office, there was a sticker on the side of the hot water heater that said "This appliance uses $450 of electricity a year." Well, I went and turned off the circuit breaker and bam! Saved $450. All we used water there for was to make coffee, flush the toilets and wash our hands. Since it took several minutes for the hot water to even get to the sinks, no one ever had hot water anyway.

Did this change my business overnight? No. Did I get a check for $450 in the mail? No. But the savings were there, equal to about $30 a month or so on my utility bill. You have to think outside of the box, and sometimes come up with creative cost-cutting solutions.

And small savings are cumulative. Just as time is the big wheel that multiplies compound interest, time is the big engine pushing debt and costs. One reason our Government is in financial trouble right now is not that we have spent a lot of money in any one given year, but rather that we have not trimmed waste over the years, and have allowed debt to accumulate.

During the last year or so, I have been able to trim my budget considerably, using the rule of small bits. I shopped my homeowners insurance and saved $500 - not an inconsiderable amount of money. I reviewed my auto policies and realized I was paying for collision insurance on a car worth $6000 and driven maybe 3000 miles a year. I saved $1500. Here and there, we found a dollar, ten dollars, 20 dollars, particularly in recurring costs (like the cell phone bill). Each savings wasn't much, but over a year, cumulatively, we've probably knocked $15,000 to $20,000 off our expenses - without changing our lifestyle all that much (Your savings may be less, we do have an extravagant lifestyle).

With debt, this works the same way. If you have $20,000 in intractable credit card debt, you did not come to this overnight. Rather, you more likely spend a dollar here and a dollar there, and every month, added another $100 to the pile, which, with interest and over time, "suddenly" balloons to twenty grand.

Weight loss, as I discuss in my companion blog, works the same way. You run a calorie surplus of maybe 50 calories a day for a decade, and you will be 60 pounds overweight. It does not take much, just an extra snack or a candy bar. "Suddenly" one day, you look in the mirror and you are overweight.

Trying to fix such problems with radical solutions, like cutting all spending, or starving yourself rarely works. Problems that take years to manifest themselves can take years to fix. The Federal Budget crises will not be resolved by years end - or perhaps even by the end of the decade. But we can make progress on all fronts.

The Rule of Small Bits applies in other areas as well. For example, Gambling can cause you a world of pain, but not all at once. Rather, the gambler dies by a "death of a thousand cuts". What do I mean by this?   Well, let me explain.

Every gambler I know has a gambling problem.  And every gambler I know insists they don't.   When you ask them about their gambling habit (and it is a habit) they rationalize it away by saying, "Well, I went to the Indian Casino last weekend, and I won $50!"  Gamblers tend to selectively remember wins and forget about losses.

If you push them on the latter, they will admit, "Well, most weekends, I come out behind, but usually only by $50 or so.  But if you factor in all the free drinks, and such, it is not a bad deal, for the entertainment involved!"

Again, the gambler deceives themselves, as the losses are likely much higher than that.  And unlike "high rollers", the gambler is not often "comped" meals and rooms.  So the overall expense, including travel, is higher than they'd like to admit.

And some would argue, "Well, what's wrong with spending $50, $100, or even $200 a weekend on gambling losses?"   And again, the Rule of Little Bits applies.

Suppose our gambler spends one day a week at the Indian Slots and loses $50 each time.  Over a month, that's $200.  Over a year, that's $2400.   Over a decade, that's $24,000. For the average middle-income person, that's a lot of money, particularly as a percentage of their disposable income.

That money, invested at compound interest, over the years, could be well over a hundred thousand.   Yet many gamblers I know have little saved, hoping for a big casino win to fund their retirement.

Most of the gamblers I know are middle class or lower-middle-class people (mostly lower) and a surprising number are poor. They have serious money issues, but would never consider giving up gambling as one approach to solving their money problems.

And here is where the law of Little Bits doesn't apply in the cure: You can't "wean" yourself from compulsive gambling (and there really is no other kind) by trying to cut back or taper off your participation.  Gambling, like alcoholism or drug use, is one of those "cold turkey" kind of things. It may take us years to become gambling addicts, or drug addicts, or alcoholics, but we can't afford to spend years undoing that kind of behavior - and the taper-off approach rarely works.

Gambling is a very bad idea.  It is nearly impossible to go to a casino to "gamble a little bit" as it is to go to an "all you can eat" buffet to "have a snack." You can't have a credit card in your wallet and go to the mall and expect not to spend. No one has that kind of self control, and that is just what they count on - your human weakness. So whenever possible, just resist the temptation by avoiding it entirely.

So for many types of behavior, we find that small bits of excess over time can result in large problems that may take small bits of corrective behavior, over time, to fix. The only exception to this Rule of Small Bits is in the case of addictive behavior, which generally requires a "cold turkey" approach in order to fix.

And sometimes this means cutting up credit cards, stopping the habit of "shopping", avoiding the "all you can eat" buffet, kicking the drug habit, or stopping gambling altogether.

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