Friday, November 12, 2010

The Cost of Things

One question that I frequently encounter is "where the heck does all the money go?"

People try to live frugally and yet still wonder why they are "broke" all the time.  Most people live this way.

In part, this is because we tend to increase our spending to accommodate our income level. If you are making $20,000 a year, you might buy a $2000 car and not get collision insurance on it. If you are making $100,000 a year, you might buy a $50,000 car. Both perform the same function, but one costs far more than the other.

Similarly, if you are wealthier, you may live in a larger house, and thus pay more in taxes, insurance, mortgage payments, and utilities.

The secret to getting rich (accumulating wealth) therefore, is to live a lifestyle below your income level. This is not easy to do, as your peers will pressure you to conform to a lifestyle level that they aspire to. It is sad but true, but humans spend an inordinate amount of time doing things to impress other people.

Yes, even those who claim to be altruistic do this. Especially those people. As I have noted before, the guy driving the Cadillac does it in part to say "I'm better than you, I can afford a Cadillac!" But the person who claims to be living an eco-friendly "green" lifestyle and gets involved in all sorts of "causes" and "issues" is often doing it for a similar reason: "I'm better than you because I'm more politically correct!". You may think this is not true, but the next time you are with your hippie friends, note how much time they spend asserting their moral superiority compared to the great unwashed masses. This is the sort of attitude that sells a lot of Toyota Priuses.

So regardless of your political leanings, one secret to happiness and wealth is to give up entirely on trying to impress unknown others, and to do things for your own internal motivations. It is hard to do. Living in a smaller house, driving a cheaper car, these are all things that save a lot of money over time, while really not affecting your lifestyle significantly.  But they are things that might subject you to ridicule from friends, family, and neighbors.

As I have noted again and again, money does not go out the door in huge chunks, but rather in dribs and drabs. A little paid too much here, an extravagance there, a light left on there, the water left running here. Policing these small costs can result in a large increase in the amount of disposable income you may have, as I have noted before. Your disposable income may comprise only 10% of your overall income, so if you can cut 10% of your expenses, it is like doubling your disposable income.

So where does all the money go?  Like Boyle's Law, the amount of spending often increases to accommodate income, just as gas expands to fill the container you put it in.   Or put another way, your goldfish will grow to be as large as the bowl he is in will allow.  Put him in a larger bowl, he will grow larger.  Try to put him in a smaller bowl, he will die.

It is thus human nature that when we make an additional dollar a week, we first think (subconsciously) about spending it.  Or, if we get out of debt, we assume that we no longer need to track expenses.  Not so!  Cutting costs and watching expenses is a full-time job, just as counting calories is, if you are overweight.

One secret to avoiding the pitfall of "spending it all" is to squirrel away money regularly.  The 401(k) program works well for this, taking money out of your paycheck before you see it.  If you get a raise, increase your 401(k) contribution accordingly.  Already maxed out?  Then have the increase deducted from your checking account to fund a savings account, stock account, or even savings bonds.  As the old adage goes, if you don't see it, you won't spend it.  Self-control, when it comes to spending, it hard for even the best of us.

When I was making "good money" back in the day, I used the squirrel technique to good advantage.  Not only did I fund my retirement accounts, I had several hundred dollars taken out of my checking account every month to pay for whole life insurance, various stock purchase plans, savings bonds, as well as a stock trading account.  $50 here, $100 there, pretty soon, your savings are adding up.  But it takes discipline to do this, and to make sure your deductions do not result in bounced checks.

The mistake I see many making is trying to play "catch-up" in savings, by having massive amounts deducted from their pay, only to end up bouncing checks when their lifestyle ends up under-funded.  You are better off starting out young, putting aside $50 to $100 a month and letting time work for you than to spend it all when young (on trash) and then try to play "catch-up" later on.

The other thing is to look at your expenses and cut them, and then increase your savings by the same amount.  Many folks pay $100 or more a month for cable TeeVee, but fail to put money into savings.  $100 a month, squirreled away for 30 years, will result in nearly $100,000 in retirement savings, even at modest rates of return.  And yet, many "poor" people say they cannot afford to save for retirement, but have four direct TV dishes bolted to the side of their houses.

Where does all the money go?  To nonsense like that.