April 2011 – Beyond Dave

Do the Math

Now that gas prices are eating into your lifestyle, you may be considering getting rid of that SUV or becoming a Prius owner. Before you head out shopping, let’s look closely at how mpg will affect how much you spend on gas.

Pat & Joe own two cars, a small sedan and a SUV. They drive each vehicle 10K miles a year. The sedan gets 20 mpg while the SUV gets 8 mpg. With 4 kids they need at least one large vehicle. Given the price of gas, Pat & Joe are considering making a car move.

Option 1 Sell the SUV and get a minivan

At 8 mpg, no doubt about it that SUV is a gas hog. If they can replace it with a 20 mpg minivan, a 12 mpg difference would certainly cut down on fuel consumption.

Option 2 Sell the Sedan and purchase a very efficient small car that will get 50 mpg.

Wow, 50 mpg, a 30 mpg improvement.

Based solely on Pat & Joe’s desire to spend less on gas, which option should they choose?

Most people answer this question wrong – did you?

Here’s the math:

10,000 miles / 8 miles per gallon =1250 gallons of gas x $3.50 =$4,375 to keep the SUV rolling

10,000 miles / 20 miles per gallon =500 gallons of gas x $3.50 =$1,750 for a minivan

Pat & Joe would spend $2,625 less on gas if they replace the SUV with a minivan.

10,000 miles / 20 miles per gallon =500 gallons of gas x $3.50 =$1,750 for the sedan

10,000 miles / 50 miles per gallon =200 gallons of gas x $3.50 =$700 for the high mpg car

Pat & Joe would only save $1,050 if they replace the sedan with a high fuel efficiency car.

This is yet another example how our intuitive answer is often wrong.

Rick Larrick & Jack Soll write about this at their scientific blog, The MPG Illusion.

Break through thinking, if you don’t need it, don’t buy it.

When I first started playing with this “get out of debt” thing, I did it quietly for two months. I cut out mindless spending, cut way back on eating out, changed a couple of insurance policies, cancelled some subscriptions and paid off my truck.

One of my mindless spending habits was Target. For the longest time, I would take my Mom to Target on Sunday afternoons. We could get things she needed while I was around to help load and carry them. The habit was an easy way to be sure I spent time with her every week because my job kept me so stupidly busy Monday through Friday.

What did I buy? I wish I could tell you. I know I spent about $100 every Sunday. I know I rarely had a list of things I needed. It was shopping for entertainment and I don’t even like to shop. One thing I remember that I bought every week was a big busy bone for Higgins. It cost about $6. If I did that every week for a year, that was $312!

Some of that $100 was for things I needed; paper towels, toilet paper, cleaning stuff; but most of it was impulse buys. Looking at what I spend now, I estimate that 25% of the $100 average weekly trip went to necessities. Eliminating Target mindless spending allowed me to put $7800 over the course of 24 months towards killing debt.

If you are just getting started on this thing, before you take your next trip to Target or Wal-Mart or wherever, take everything out of the cupboard where you keep cleaning supplies and inventory it. How many cans of Pledge, bottles of Febreze or boxes of Swiffer refills do you need? Don’t buy any new products until you’ve used up the old.

When we replaced our windows years ago, the installer recommended cleaning them with a mixture of 10% cheap white vinegar, 90% water with a bit of Dawn detergent – if they are really dirty. This same concoction works great on our bathrooms and counters and floors (just not marble). One spray bottle: cheap, easy, and effective.

Do the same for your pantry. Is there really a need for 4 jars of peanut butter? Take everything out; inventory it and figure out how to use it up.

So, what about getting together with Mom? Our regular outing is now to the library. We still go to Target occasionally, but if there is nothing on my list, I don’t buy anything. And as for Higgins, he is glad to have a walk instead of a bone, any day.

How Much Money Would it Take?

I have a great “get out of debt” story, but I am sometimes reluctant to share the details. When we decided to do this thing, we really did it. Without selling anything significant or inheriting anything or winning the lotto, we paid off $220,000 in debt in just 24 months.

During that period, we had a significant income. I had a great paying job, we had several side hustles and Jim had retirement income.

My reluctance to share the numbers of our story stems from a fear that some will use this as another reason that they can’t win, instead of inspiration that they can. If you hear this and think, if only I made that kind of money I would be debt free and fiscally fit too. Please read on.

People with huge incomes lose all the time, maybe even in similar percentages to those with lesser incomes.

Take for example, NFL players, the minimum salary in 2011 is something like $340K a year yet many of them are considering taking out high fee, high interest loans to get the through the lockout. (Excellent post on the subject, NFL Players, Lockout Loans, and Predatory Lending by Lazy Man and Money). This is despite the fact that the Players Association will pay them $60K over a six-week lockout.

Dang, at least $340K a year and they don’t have any savings to get them through a rough patch even after a $60K payday? What kind of fools are these guys?

Wait a second, they are the same kind of fool that I was. They spend all, or most of, or more than they make. They build no safety net into their finances. Banks have offered them easy money to buy the glittery stuff that their peers were wearing or driving and they took this to mean they could afford it.

The key principal of financial success is the same whether you make $35K or $340K .

Spend less than you make.

If you need to dump debt – spend significantly less then you make.

If you are like me and you really, really NEED in your heart to be free, find a way to live on the smallest possible percentage of your income.

Mine was 21%.

Fool

You are a self-sabotaging, irrational but often altruistic toad – however I say that with love in my heart. It’s not just me who thinks so; turns out there is a whole science devoted to the “how and why” we make the choices we do. Guess what they discovered – we are all hopelessly irrational.

Behavioral Economics is a rather young science that merges economics with psychology in order to study how real people make choices. When making decisions, we would think people choose the option that maximizes profits and benefits to themselves, right?

Let’s think about it. Are the decisions you make about your money, your health or your future rational?

Have you quit smoking or paid off your debt? Do you exercise and eat right? Are you saving enough for retirement? In short, are you doing the things that you know will lead to your goals?

Smart people behave irrationally (so do dumb people). It is a scientifically proven fact that we knowingly make decisions in direct conflict with what we want to happen. In addition to choosing poorly, we often sabotage our futures by refusing to choose.

David Laibson, Professor of Economics at Harvard writes; “There’s a fundamental tension, in humans and other animals, between seizing available rewards in the present, and being patient for rewards in the future,” he says. “It’s radically important. People very robustly want instant gratification right now, and want to be patient in the future. If you ask people, ‘Which do you want right now, fruit or chocolate?’ they say, ‘Chocolate!’ But if you ask, ‘Which one a week from now?’ they will say, ‘Fruit.’ Now we want chocolate, cigarettes, and a trashy movie. In the future, we want to eat fruit, to quit smoking, and to watch Bergman films.”

I know Laibson is talking about me. I definitely want to eat better and exercise more – later.

When it comes to our money, we buy stuff on credit even though using credit reduces the amount of stuff we can buy. We walk away from free money in the form of our employer’s match on our 401k and we fail to make a budget or set aside an emergency fund even though we readily agree that these are all things we want to do.

How do we overcome our irrational desires?

I win with my money not because “I’m oh so smart“, but because I’ve finally accepted that guys like Laibson and Ariely are right. To paraphrase Pogo, “I have seen the enemy and she is me”.

Recognizing that the biggest danger to my financial future is my own irrational decision-making, I have set in place a system of pre-commitments that force me to follow through my rational plan.

Here are things I do that will work for you:

Make a budget in ADVANCE of the month and sign off on it with your spouse or accountability partner. Hold each other to the commitment.

Don’t give yourself easy access to money or credit. Cut up the credit cards or at least hide them. Make your savings harder – not easier to get to.

Make savings automatic – have your savings direct deposited or at least moved automatically as soon as it hits your account.

Post the Wish List on the fridge – don’t buy things that aren’t on the list even if you have the money.

Want to learn more about Behavior Economics?

Dan Ariely, Professor of Behavioral Economics at Duke has a podcast at ITunes U called Arming the Donkeys. The segments are really short, interesting and easy to understand. Give it a listen.

The Big Splurge

My friends & clients often want me to be the fun police. I’m really not against fun nor do I hate stuff, but I do recognize the glassy-eyed look of car, vacation and boat fever.

Live Intentional

Most people would agree our lives are happier, healthier and more productive when we act intentionally – rather than being possessed by consumer fever. This means we do our best every day to align our behaviors with our goals. We dream about and plan our futures.

Even though I’m committed to this intentional thing, I still fall prey to marketing, and impulse, – falling off the wagon from time to time. But because I have learned to recognize the warning signs, it happens a lot less than it used to and it involves much, much smaller sums of money.

Big Red Flag

Driving down the road you see a shiny car (or boat or motorcycle) parked in a lot, sporting a hand drawn For Sale sign. You stop look and then spend the rest of the day working yourself into a “must have” frenzy.

This car, (or boat or motorcycle) is not on wish list posted to your fridge. You have not earmarked money specifically for this purchase. In fact, until you saw it you didn’t even know how bad you needed it. This is a BIG red flag.

When locked into this “gotta have it” state, our powers of rationalization are phenomenal. Just sit back and listen next time you are around a potential buyer in a frenzy.

“I haven’t treated myself in sooo long.” Oh, cry me a river. Maybe you haven’t “treated” yourself in so long because you’ve been trying to climb out from the giant hole you created the last time you treated yourself.

“I’ll never find another one (the car, the boat, the motorcycle) this good ,this cheap, this color blah blah blah .” Oh please, how you would even know – you weren’t even looking for one.

“If I just had this……” Right, think back , these words came out of your mouth when you were five too. “Mommy, if I just had this one toy, I’d never ask for anything else.” Did you really mean it then? Do you mean it now?

Spontaneous

Being intentional does not mean you need to live a locked down life without the room for spontaneity. I want you to be able make a purchase “just because”, in fact, we set money aside for that at the beginning of the month, it was your blow money.

If you make enough and save enough, your blow money budget might allow you to buy a car (or boat or motorcycle), but for most of us, that is a major purchase, not an impulse buy.

Decide

Ok, so you have the money available (cause you are going to make me nuts if you are even considering making this purchase with credit) and it’s unnamed (this is exactly why we name all our savings) and you want it really bad, ask yourself:

What does it cost?

I mean really cost. Total the original purchase price, the tax and fees, the upkeep the insurance etc. Now convert that to how long you have to work to pay for it. That is what it costs in terms of your life. Right now today would you trade that chunk of your life for this purchase?

Is this the highest and best use for this money?

What are the chances that before you can replace this money another (better) opportunity will arise?

Maybe your daughter will decide to marry; do you have that covered?

Maybe you’ll have a chance to take a job you’ve always wanted but it will require an expensive move, is this purchase worth missing that opportunity?

Is this purchase in line with my current values, goals and dreams?

If you have asked yourself these three questions and still want to make the purchase, go stand in the cold shower until the feeling goes away.

Break the Chains

Did you inadvertently and unknowingly trade your freedom for a flat screen TV, dinners out and a drawer full of obsolete electronics?

Joe Plemon recently published an excellent blog titled, What is Your Debt Actually Costing You? In addition to the dollar cost, in terms of interest paid, that comes to mind immediately, Joe lists lost opportunity cost, marital costs, health costs and what he calls the creativity costs as components of the actual cost of debt.

Any one of these costs can be devastating to your happiness.

Let’s look more closely at what Joe calls the Creativity Cost of debt.

If your debt load has you stuck in an unhappy, unhealthy job, I’m sure you’ll agree that creativity cost of debt is way too nice of a term to describe what is holding you in your situation. That debt is costing not just your creativity but your freedom as well.

I live in an area of historically low wages and current high unemployment. I have heard from several people that even businesses that have not been hurt by the recession are using the tough job market like a baseball bat to beat up their work force.

Employees find themselves charged a larger percentage of their healthcare costs, given heavier workloads and constantly threatened with pay cuts, reduced hours or unemployment.

Scared by high unemployment rates, dropping wages and mostly by their own precarious financial situation, many remain chained in miserable jobs and suffer day after day.

If you are currently employed by a Simon Legree and feel you cannot leave because of the mountain of debt you owe, you not only understand “the borrower is slave to the lender”, you feel it.

The situation should make you angry. You should be mad that someone would use economic news instead of your companies actual economic reality to influence jobs and wages.

You should also be mad that you allowed yourself to be painted into this very uncomfortable corner.

There is little you can do about your employer’s lack of empathy – but there is a lot you can do about your own vulnerability.

Use this anger to fuel your new financial rebirth; get so mad about your lack of options that you swear to never again go into debt or to be without a big emergency fund.

Remember these feelings of anger and powerlessness and call on them to motivate you to really attack your debt this time.