WHEN I TAUGHT economics, I would present students with the financial misunderstandings that people often have—and which the study of economics can help them avoid. Examples? Here are five widespread misconceptions:
Mistake No. 1: The rarer something is, the more valuable it is. Economics really doesn’t care about rare things—meaning those things that are few in number. Instead, economics deals with scarce things, which are things for which there’s greater demand than current ways to fulfill that demand.
Why does this matter? People get tricked all the time into buying things because there aren’t many of them or because they may not be around tomorrow. How often is your interest piqued by the phrases “limited offer” or “for a limited time”? The items involved may indeed be rare. But for them to be scarce, you need to actually want them. Do you? Or have the marketers prompted you to feel a false sense of urgency for something you don’t really desire?
Mistake No. 2: Comparing choices is about comparing benefits. There’s a reason it’s called cost/benefit analysis. You need to consider not just the benefits of each choice, but also the costs. Everything has a cost—including not only the initial price and any ongoing expense, but also the lost benefit from not opting for the other choice.
Mistake No. 3: You borrow from others. When I ask students who they borrow from when they charge something to a credit card, most will say “the bank.” But the right answer is “your future self.” The debt will have to be repaid by your future self, along with any interest owed. In effect, you’re betting that the money you borrow is worth more to you today than it is to your future self.
Mistake No. 4: Savings are what are left when you don’t spend. When people get money, they look to spend it. If they can’t find anything they immediately want to buy, they hold on to it. This makes saving money seem like the last choice, the fallback option after looking at all the shiny objects currently on offer.
A better way to think about savings: View them as future spending. Do I want to spend now or delay spending until later, when—thanks to prudent investing—the money might have more buying power? By framing the issue this way, you also remind yourself that you won’t be the same person in the future—and that your future self will likely have greater financial needs and more expensive tastes.
Mistake No. 5: The goal is always greater wealth. Today, many financial services are about “wealth management.” But in the end, we don’t want more money, but rather greater contentment, satisfaction and even happiness.
Money is merely a tool. To use economic jargon, it’s a factor in the production of your happiness. Figure out your goals and then figure out how money can help you get there. It might even be that earning less money, and perhaps spending more time with family, is what you should really be aiming for.
Jim Wasserman is a former business litigation attorney who taught economics and humanities for 20 years. His previous articles were Spoonful of Advice, Under the Influence and Gaming the System. Jim’s three-book series on teaching behavioral economics and media literacy, Media, Marketing, and Me, will be published in early 2019. Jim lives in Granada, Spain, with his wife and fellow HumbleDollar contributor, Jiab. Together, they write a blog on retirement, finance and living abroad at YourThirdLife.com.
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Question…is the inability to give of ones time, talent and treasure a symptom of another deeper issue ??
Thanks for this thoughtful piece:
Mistake No. 1 is straight-forward and helpful.
Mistake No. 2 is worded in a way that my simple mind cannot understand and reconcile what part is the “mistake,” in relation to what is the recommended view. (I often misunderstand such things.) The referral to “cost/benefit analysis” is clear to me.
Mistake No. 3: I have stored much of my family’s wealth in rental real estate. When we’ve borrowed money, I have thought in terms of getting others to repay it. (This view also leads me to respect those— “tenants”—who do the repaying. This “respect” comprises the key element of the value we provide by making homes available for short terms. It has worked out well.)
Mistake No. 4 is my personal favorite. I have gotten a number of people engaged in the fine habit of “Pay Yourself First,” to great effect. Turning around the save-vs-spend concept is excellent. The “Savings is your first choice” formulation will aid my efforts.
Mistake No. 5 ought to be obvious. The fact that it clearly is not, makes this a great point for ending the short list.
We’ve read the assessment that the comfort level of income in life starts at somewhere around $75,000 per year, but doesn’t increase beyond some surprisingly low, upper limit. It recently occurred to me how much of my personal “happiness” comes from having removed “basic financial worry” from my mental worry list. In this late-life position of retrospect, I could not stress it more-strongly:
Pay yourself first. With the passing of time, your concerns over financial security will disappear. With surprisingly little wealth stored, you can focus entirely on pleasures, family, friends, and the personal goals of your life.
Re-framing one’s thoughts may be the best way I know to learn new things out of one’s own personal stored knowledge.
Jim – Thank you for these insights, especially #3. My present self is now congratulating my past self for stopping doing some really dumb stuff that would have cost my present, and recent past selves, a lot of money. I think you may even be as smart as your wife! I’m looking foreword to reading more from you. – Dave
Thanks, David, though I wouldn’t even begin to claim to be as smart as my wife. On the other hand, I do have far superior taste than she does in choosing a spouse!
I suspect our wives have a lot in common.