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Managing your financial life requires following three rules:
No. 1. Spend less than you earn;
No. 2. Prioritise investing for your future;
No. 3. Figure out what matters and spend accordingly.
If you follow these simple rules, you can ignore the rest of this column. Heck, follow just the first one and you can pretty much ignore everything else.
The reason for bringing this up is yet another appearance by the spending scolds. These finger-wagging austerians love to warn of the dire consequences for anyone foolish enough to actually spend their money.
At almost every level, these complaints are absurd and the arguments marshalled in support are ridiculous.
A recent entry contains this warning: "Buying new cars is like taking $40 000 (R575 000) and setting it on fire." The 17.1 million people who purchased new cars in 2019 might disagree with that sentiment. After all, those who light their cash on fire have only a pile of ashes to show for their efforts; the new car buyers have, well, a new car and wonderfully reliable transportation.
The stupidest beliefs about money
After working for three decades in finance I've reached this perhaps overly broad conclusion: People are weird about money. Never mind the countless anecdotes I could cite, the entire field of behavioral economics backs this up. Our weirdness is demonstrated by the foolish financial decisions we make each day, the unsupported beliefs we hold dear and the odd pronouncements made whenever the subject of spending comes up.
Some examples of this include:
- You're flushing money down the toilet if you drink a latte
- It's financial suicide to own a house
- Never buy a boat or a sports car
- Don't send your kids to college
Underpinning all these warnings is a fundamental misunderstanding about the difference between a) spending and b) spending beyond your means.
The former is how we acquire the goods and services we need to go about our daily lives, or the things we want because we get enjoyment from them; the latter is an error in judgment, a behavior fraught with risk that really does have the potential to lead one down the path of financial ruin.
Simply saying no to consumption is lazy and thoughtless. What should determine personal spending is the totality of the buyer’s financial circumstances.
Aside from the fact that the spending scolds so often are wrong, they also tend to be tedious bores. Invariably, they cite some very wealthy person who lives frugally, implying that you too can acquire great sums of money just by being cheap. This is, of course, a deeply flawed argument that totally misunderstands the most basic issues of how household budgets work.
This is the message of some recent stories citing the thrift of National Basketball Association star Kawhi Leonard. Yes, he has a three-year $103 million contract with the Los Angeles Clippers, but at least until recently he drove a 20-year-old SUV.
Yet here's the thing: You could skip buying a new car for the rest of your life and you will still likely never be as rich as Leonard by virtue of the fact that you don't have a $103 million contract.
By the way, he hasn't really skimped on his housing. But so what? He can easily afford it based on his huge annual income. And he probably should buy a newer car with better safety features, reducing the odds of a catastrophic injury that prematurely ends his playing career.
This is the key that the spending nags all seem to fail to understand. It is all about living within your means, not living like a pauper whether you have to or not. The formula is simple: Spend less than you make. Make intelligent decisions. Don't pretend to be something you are not by spending more than your income justifies. You do not need a business degree from Wharton or anywhere else to figure that out.
* Barry Ritholz is a Bloomberg columnist. Views expressed are his own and do not necessarily reflect those of Fin24.
