Why Don’t We?

Posted by Robert on November 22, 2010

This is a guest post by Robert, who lives in Calgary and works as a financial adviser. He is married, has three kids and plans to retire at age 35.  Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.

Personal finance is simple and it’s intuitive. Most people, if asked how they should handle their money, know they should spend less, save more, invest wisely and eliminate debt. Seriously, it’s that easy. So why aren’t we all successful at managing our finances?

I believe that the disconnect lies in the gap between knowing what to do and actually doing it. The hard part is finding the motivation to put it into action.  This is because it goes against our natural inclinations and so it feels uncomfortable. It’s easier to go into debt and get the things we want immediately, rather than to wait and save up. The matter is complicated by the examples we see around us. Because money is a taboo subject in our society, most people don’t discuss how they pay for things or what they do with their money. If we don’t see people eliminating debt or saving for years, we only notice them spending large amounts and we risk feeling jealous. We easily rationalize that if they can spend so “carelessly”, so can we.

In order to succeed, we need to counter these natural tendencies. The first step is to create a plan that really works. For example, in its simplest form, a personal financial plan may state: “Starting from my current assets, if I save $800 per month for eighteen years, I will have around $800,000. That should provide $40,000 per year after-tax income, which will provide for my needs in retirement, after pension income. At the same time, paying $300 per month toward debt will ensure the debt is paid off in ten years. The money I save will be invested 80% in the stock market, 20% in bonds, to provide the growth I need and some amount of certainty.” This plan is very rational, it provides the required steps and the expected outcome. It could work, but only if it’s put into practice.

It would be very uncomfortable to go from spending all your income to diverting $1100 (in the example above) to savings and debt repayment. For that reason, most people will get to the end of the month, realize there’s very little money left (if any), and fail to make progress. One idea is to make the payments automatic. Trying to talk yourself out of spending is difficult. If the money is simply not there, the decision has already been made. Many people notice that they barely miss the money that was withheld. The government knows this, which explains why income taxes are withheld from our paycheques. If you’re able to make a rational decision about saving, but not able to follow through and reduce spending enough to save money, try making it automatic.

Another option is to find examples of the behaviour you want to have. A good example is RRSP contributions. In the late 1970s, very few people contributed to an RRSP. The tax incentive had been introduced, but few people understood the program. Today, banks and other financial institutions have huge ad campaigns around “RRSP season.” It seems that everyone is contributing to an RRSP and many people feel guilty if they don’t contribute at least a portion. This makes it much easier to make the (otherwise uncomfortable) choice to save, because it feels like the default choice.

Personal finance is interesting in that it’s simple to know what to do, but that doesn’t automatically translate into financial success. Taking the steps that lead to success, including spending less, saving more and reducing debt feel uncomfortable, which causes some people to make choices contrary to their own plan for success. Taking steps to surround yourself with good examples and making those actions as automatic as possible helps to avoid the discomfort that otherwise might be experienced.

Do you have automatic savings? Other than this blog, where do you find good examples of wise financial choices? How else do you get things done when you know it’s important, but it feels uncomfortable?

There Was No Post Today Because…

Posted by Canadian Dream on November 19, 2010

It is current 3:30pm (SK time) and I have yet to write a post today.  I would like to think that I will write one, but they way today is going the odds of this is approaching zero.  Thus rather than bore you death with the real reason I didn’t get it done let’s try a little creative writing exercise.

Finish the following sentence below in your comment:

There was no post today because….

I’ll go first… Tim was abducted by aliens had all his financial knowledge stolen and he has spend the rest of his day in happiness since he can no longer recall what why mathematical modeling would be considered fun or why anyone would obsess over retirement.

The best comment chosen by me will be featured on the start of my next link post and be the theme for that post.  Good luck to everyone and please have fun.

The Underlining Assumption

Posted by Canadian Dream on November 18, 2010

Perhaps one of the most dangerous things we do in our lives is we don’t even look at our underlining assumptions. For example, we drink coffee every morning, but why?  Perhaps the answer is we like the taste of it? Really, it is sort of bitter tasting and it tastes awful when it gets even slightly cold.  How about the answer is we like that bit of caffeine in the morning. Yet the reality is we can get that elsewhere.  So what are we missing, why do you drink coffee in the morning?

In the end, it is a habit and we assume that we want it.  Our lives are considered normal to ourselves.  So everything you do from your point of view is just the way things have always been.   Until you are exposed to another source of ideas you may never change a behaviour or habit because you literally can’t see past your own life yet.  As an example, growing up I recall someone telling me they knew what they were having for supper since it was Friday.   I was amazed that he knew this early in the day.  He then told me they always eat the same thing every Friday.  I was stunned since in my house I didn’t see the same meal again typically for months at a time.

So what the hell does that have to do with anything?  My spending patterns are basically a shock to some people because they can’t see past their own lives yet.  If you grow up in a city with similar people around you and you rarely meet others that have significantly different spending habits it becomes hard to see past them.  Your spending habits are mostly just an underlining assumption that you have made that everyone lives this way.  So to meet someone significantly different is a bit of shock.

Yet once the shock has hit, how do you use that to see past your normal life and make change?  Well that is going to be partly a personal journey to find you own motivation to look at changing your life, but one quick method to generate some ideas is the following exercise.  Assume for a moment that every decision you have ever made in your life with regards to your purchases are wrong.  Yes you bought the wrong house, car, shoes, socks, dishwasher, teapot and the wrong brand of tea.  Now try to justify to yourself what you really should have bought instead based on what you really need.  Take some time with this and don’t let yourself give bullshit answers.

This might lead you to consider you have a 1500 square feet house with approximately 250 square feet of junk you don’t use.  So the reality is you bought a bigger house than you needed because of the junk, not because you personally actually use that extra space.  Or perhaps you look at your wardrobe and realize you only like to wear half of it.  The rest was mainly impulse buys of things you have never used.

By freeing yourself from you underlining assumption that your life is normal, you can finally start looking objectively at your own life.  When that occurs you can finally start to really look at your spending and find easy ways to save a little bit more.  By repeating this behaviour over a number of years you can actually manage to have the majority of what you enjoy now in your life at a fraction of the cost.  It is a little scary to realize how much money you have been wasting for months, years or even decades but the pay off is more saving, less crap in you life and potentially an earlier retirement date.

I know this concept can be a little hard to grasp for some people, so let’s play a little game.  In a comment write down the first five things you touched with your hand this morning.  I’ll go first: alarm clock, water glass, eyeglasses, bathrobe and door.  I will bet the majority of people will have a common item or two in their list, but not everything.  That is because your normal life is just a little different than everyone around you.