One aspect of financial planning that is often neglected, even though it is perhaps the most important aspect of wealth generation, is a person’s savings rate. The rate of savings varies greatly, even among our clients. And though you will often hear how little people save and how as a society there is dearth of savings, we find that there is a substantial subset of people where spending is avoided as much as possible. Just as some people have no problem splurging on items, others dread spending, often to a fault. Both extremes are problematic, and this where we think the advice to think like an economist comes in handy.
We do not fancy ourselves an economist; though we took micro and macro economics courses at MIT, that is the extent of our formal economic education. However, there is an economic way of thinking that many so called lay people or non economists use when analyzing things. Human nature often gets in the way of economic thinking, and even some economists fail to think like an economist. Everything in life involves trade-offs. We live in a world of scarcity, and money is a medium for exchange; it allows us to convert our production and investment for consumption.
When we choose to spend or save, we are making a tradeoff between consuming now or consuming in the future. Overspending now means jeopardizing your future; it takes a certain maturity in order to delay gratification for some far off goal. Some people are just hardwired to be able to delay gratification, but for those who aren’t, it is essential that they think like an economist – they need to make a long term investment for their future self.
Now, even though it is probably more common for someone to be a spendthrift vs. an extreme saver, sometimes extreme savers need to get a dose of thinking like an economist. Some people will fret and excessively shop around to save a couple dollars. They want to get the best deal. They want to get the most value for their dollar. And it is human nature to look at discounts or savings in terms of percentages, but percentages are meaningless- it is the actual dollar amount that is important. People will not think twice when adding a $500 option to a new car or thousands of dollars of upgrade to a new house. It is because these numbers are small percentages of the total price. Yet they will comparison shop endlessly to save $5. An economist would find that silly. Not rational. People don’t make rational decisions all the time; it is human nature. Sometimes we need to step back and not sweat the extra $5.
Don’t get us wrong, we hate waste and spending money needlessly (we admit, we often catch ourselves as one of those excessive comparison shoppers). But we’ve also seen people pinch pennies excessively when they have no need to. The time will come in one’s life (usually), when one needs to transition from the accumulation phase to the spending phase of their assets. This is not easy to do.