Not all Dollars are born equal.
I think the answer lies in my lack of self-control. Not only do I lack self-control, I know I lack self-control, writes Peter Ellen.
February 4, 2013 5:30 by kippreport
Why is it that I save money in a low interest bank account, but take out a car loan at a much higher interest rate? Are the dollars in my savings account worth more than the dollars I use to buy the car?
This question puzzles a lot of people, especially me, and it is a very important question to think about when considering why people don’t save for their future.
I think the answer lies in my lack of self-control. Not only do I lack self-control, I know I lack self-control. It makes me afraid – afraid that if I use the money in my savings account (that I am saving to buy a house) that I will not pay myself back, and thus I’ll end up with a car, but not the deposit on a house. I know I have to pay back the car loan, because it is with someone outside (a bank), and they will chase me until I do pay.
It goes further than this. In my head, and recorded on a piece of paper that I update every month, I have created artificial budgets that I use to allocate my monthly income – so much for rent, so much for car expenses, for the car loan, for food, for the kids’ schooling, for entertainment, for saving, for insurance and so on. This is helpful in that it shows me whether I have enough money to last me the month – cash is king when it comes to budgeting. But, it is less helpful when I can’t break down these artificial budgets and transfer money between them to optimise my wealth. If I run out of money for food, can I transfer it from the entertainment budget? Should I? What about from the savings budget? How do I prioritise the different budgets to know which is the most important?
Not all dollars are created equal.
How I spend my money does not make sense, if I look at it from a purely economic standpoint. But then I am not a purely economic entity – I have a personality (of sorts) and if I want to understand my behaviour, then I have to understand behavioural economics as well as pure economics. There is a lot written about the subject, but I still don’t seem to grasp the fundamentals sometimes, and thus go on mis-allocating my spending.
Why am I more likely to blow my winnings from the lottery than save them? Why am I less likely to spend a profit made on stocks and shares, or because my property has increased in value? Why, if I start to save for my pension, is my other saving likely to increase, too? Why, if I want to raise some cash and need to sell some stocks, am I more likely to sell a stock on which I have made a profit than one where I am making a loss? All these questions can only be answered if I understand behavioural economics and how not all dollars are created equal.
It’s because of the complexity involved in the dynamic mixture of money and personality that I first went to a financial adviser. He was able to help me with a lot of these questions – not that he understood behavioural economics any better than I did – but in a very practical way, by making me aware that I needed to set real and meaningful goals and then fund them over a long time, so that I could achieve a balance between income distribution (spending my salary wisely) and wealth creation (building a nest egg for my and my family’s future). I wouldn’t dream of advising anyone else about their finances, but I would recommend to everyone to find a trustworthy adviser to help them.
Peter Ellen is Operations Director at Nexus Insurance Brokers www.nexusadvice.com and has extensive experience in the area of sales management and leadership, sales and sales management development and operations management. He has worked in the industry for 28 years in senior management positions and as a consultant, working with regulators, product providers and distributors. To contact Peter for advice with any insurance and investment advice please email him at [email protected]