Spending too much? Here's how to avoid it
Indulgent spending can lead to
difficulties when financing mandatory expenses in the future. Before spending,
bear in mind your income, and unavoidable monthly expenses
Wealth building does not start if
there are no consistent savings. Unless there is some balance in the bank,
before the next salary comes in, we are not generating a surplus, and we will
not be able to contribute towards our future financial well-being. Income tends
to trigger expenses, not savings.
But, without a handle on how we spend, we may not be able to move forward on financial planning.
But, without a handle on how we spend, we may not be able to move forward on financial planning.
How and why we spend is quite a
complex subject. Psychologists have studied the power of persuasion, so
amplified by advertisements and promotions that create needs where none
existed. Brands have been built to sell products and services at premium prices
that cater to the psychological needs of shoppers to feel important, socially
accepted, privileged and exclusive. In the film Confessions of a Shopaholic,
the protagonist, Rebecca, turns to shopping to deal with a range of emotional
downturns -loss of a job, friend or lover conundrum. Retail therapy is a known
remedy to get serotonin and oxytocin levels up.
Modern cognitive psychologists have
used advanced technologies to map the brain. Antonio Rangel, professor of
behavioural biology and neuroscience, Caltech, has conducted experiments that
scan the brain when it makes money-related decisions. The ventral medial
prefrontal cortex is activated when we judge a product on its immediate value
to us. A rising stock, an appetising meal, or an expensive gadget appeals to
this part of our brain, which is activated when we make impulsive decisions.
Another part of the brain -the dorsolateral prefrontal cortex (DLPFC) -deals
with more abstract long-term consequences. An active DLPFC would prompt us to
check the stocks' fundamentals, remind us of the health consequences of a
high-calorie meal, and warn us about the dent the gadget would cause to our
retirement savings. The DLPFC is not always active; not for most spenders who
seek instant gratification, or are looking for an immediate psychological high.
It needs effort.
What can we do about our spending
habits to bring some control into our lives? It is quite old-fashioned to make
a budget. Many do not even care to know how much of their income goes towards
essential spending that is unavoidable. The first step is to have a sense of
the mandatory spending that we anyway incur, month after month. This tells us
how much room we actually have to get impulsive with spending. A mental limit
on what is available for indulgence can be set only if we know how much is not
available to spend -we have to pay rent, grocery bills, fee and staff salaries,
etc. If the mandatory spend is less then 50% of our incomes, we have the
breathing space to spend without too much stress. The higher the mandatory
spend, the er the mandatory spend, the greater the need to be careful about
what we buy and why.
The second step is a financial
strategy review of our spending on durables. A company that buys an asset
evaluates how long the asset will be used and accordingly depreciates it. Since
a household also buys durables for comfort and for enhancing its productivity, they
can be similarly evaluated. A television bought for`1.2 lakh and replaced every
two years, translates to spendings of `5,000 a month. Keeping in mind its
income, the fam ily has to evaluate if it is affordable and worthwhile. The
decision to upgrade the television should happen in this context. This would
apply to all durables. If a `6 lakh car is bought and used for four years and
it has an estimated resale value of `1 lakh, the household is allocating
`10,000 a month to it.
The third step is to measure expens
es using a percentage approach to provide a mental budget. If we assign 10% of
our annual income to holidaying, the micro decisions about where to go, how to
travel and where to stay are better managed within the context of how much has
been allocated. A family that routinely eats out and finds that the smaller
restaurant bills add up to a large expense, can bring in control if they decide
what percentage of the income should go towards this indulgence. It is then
easy to juggle an expensive brunch with a drive out to the eatery on the
highway, when the limit for the expense is close to being breached. From
birthday party to anniversary gifts, all spends can be assigned a share of the
household's income. This approach enables roping in all members of the family,
building consensus on what is available, and learning to make choices within
agreed overall limits. It is likely to turn out to be a valuable exercise in
teaching children about finance; after all, making choices within a given limit
is a fundamental financial skill that needs to be acquired.
The fourth step is to see how we are
funding our expenses. If most of our funding is from borrowings, the expenses
are a charge on the future income. The discretionary and indulgent expenses of
the present are then converting into mandatory and compulsory expenses of the
future. That will leave behind even smaller amounts for other future expenses.
This opens up the risk of credit card overuse, leading to a higher debt burden.
Households that find themselves in a
debt trap are typically those that have incurred high big-ticket expenses on
credit that curtail the ability to spend even on essentials on an on-going
basis. Not all debt is bad, but debt that takes away more than 40% of the
income leaves too little room for financial manoeuvring. When financial
planners ask households to shun debt, they warn about the possibility of debt
building up beyond the ability to repay and leading to cash and solvency
crises.
Spending tends to be mentally
associated with fun, joy and power. It is easy to overdo it when the pleasure
of swiping the credit card is isolated from the pain of paying the bills.
Budgeting and savings are associated with boredom and routine. That is why they do not receive the attention they need. Long-term wealth, just as virtue and character, is built only when tougher choices are made over easier ones that bring instant gratification.
Budgeting and savings are associated with boredom and routine. That is why they do not receive the attention they need. Long-term wealth, just as virtue and character, is built only when tougher choices are made over easier ones that bring instant gratification.
Uma Shashikant.ET140616
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