Sunday, February 12, 2006
Spending to Save, The Savings Paradox
Just about anyone who has personal finance goals consciously attempts to scrimp and save to some degree. Unfortunately, good intentions do not always result in good actions. Many people are not saving as much as they think they are and in fact, could be spending more in an attempt to save. This phenomenon is something I like to call The Savings Paradox.
The Savings Paradox is essentially the idea that to save money, one must spend more. This may sound confusing, but this is a consistent event that takes place in too many people’s life. Imagine that you saw a television on sale at a local electronics sale for $2000. You know that this is a great deal because at another nearby store the same set is selling for $3000. You purchase the T.V, proud to have saved $1000. You show your new purchase off to friends and family, who are amazed with the system (and even more amazed when you share the price). But was this purchase really such a great decision? While you might have saved $1000 by not buying the set from the other store, you still had to spend $2000 on a new television set that you did not necessarily need. So while you have spent less money purchasing the T.V than you might have otherwise, you still spent $2000!
Of course, applied to all purchases, the Savings Paradox would leave you homeless, without food or shelter and a lot of money. I am not suggesting that you never spend money in an effort to save to the extreme. I am suggesting that you question your purchases to determine the necessity of them. All goods and services can fall into one of two categories: needs and wants. Needs are things that are necessary and required to survive. This includes the obvious like food, clothing and shelter; but also includes the items that you require to live your life (such as transportation, entertainment expenses etc.) Wants are items that you desire which are not required or necessary for survival. You do not need an I-pod to survive, but many people purchase one because they want one.
While people can save money by re-evaluating how they are spending money one their needs, it is easiest to apply the Savings Paradox to “want” purchases, simply because these purchases are not necessary. Take the above situation as an example. Assuming you already owned a working television set, was it really required to purchase a new one for $2000? The best way to utilize the Savings Paradox in your life is to make a cost-benefit analysis in your head every time you purchase something. When you perform a cost-benefit analysis, you determine all of the pros (benefits) and cons (costs—both financial and other) of making the purchase. If the benefits outweigh the costs, you can justify the purchase. When the costs outweigh the benefits, you should forget about making the purchase. Of course, this only works if you are objective when determining the costs and benefits of a purchase decision.
By “shopping smarter” by utilizing cost-benefit analyses with your purchasing decisions, you should no longer be swayed to spend money on a sales item that you do not really need. In effect, you will be saving more by spending less, which is how it should be in the first place.
The Savings Paradox is essentially the idea that to save money, one must spend more. This may sound confusing, but this is a consistent event that takes place in too many people’s life. Imagine that you saw a television on sale at a local electronics sale for $2000. You know that this is a great deal because at another nearby store the same set is selling for $3000. You purchase the T.V, proud to have saved $1000. You show your new purchase off to friends and family, who are amazed with the system (and even more amazed when you share the price). But was this purchase really such a great decision? While you might have saved $1000 by not buying the set from the other store, you still had to spend $2000 on a new television set that you did not necessarily need. So while you have spent less money purchasing the T.V than you might have otherwise, you still spent $2000!
Of course, applied to all purchases, the Savings Paradox would leave you homeless, without food or shelter and a lot of money. I am not suggesting that you never spend money in an effort to save to the extreme. I am suggesting that you question your purchases to determine the necessity of them. All goods and services can fall into one of two categories: needs and wants. Needs are things that are necessary and required to survive. This includes the obvious like food, clothing and shelter; but also includes the items that you require to live your life (such as transportation, entertainment expenses etc.) Wants are items that you desire which are not required or necessary for survival. You do not need an I-pod to survive, but many people purchase one because they want one.
While people can save money by re-evaluating how they are spending money one their needs, it is easiest to apply the Savings Paradox to “want” purchases, simply because these purchases are not necessary. Take the above situation as an example. Assuming you already owned a working television set, was it really required to purchase a new one for $2000? The best way to utilize the Savings Paradox in your life is to make a cost-benefit analysis in your head every time you purchase something. When you perform a cost-benefit analysis, you determine all of the pros (benefits) and cons (costs—both financial and other) of making the purchase. If the benefits outweigh the costs, you can justify the purchase. When the costs outweigh the benefits, you should forget about making the purchase. Of course, this only works if you are objective when determining the costs and benefits of a purchase decision.
By “shopping smarter” by utilizing cost-benefit analyses with your purchasing decisions, you should no longer be swayed to spend money on a sales item that you do not really need. In effect, you will be saving more by spending less, which is how it should be in the first place.
# posted by mikeyarmo @ 11:44 AM 
