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Spend Wisely

Don’t buy stupid stuff. Spend wisely. It’s the age-old advice that we’ve all heard.

“Spend wisely” sits at the intersection of psychology and practicality. Owning stuff causes pain, and it weakens our defenses against the bad stuff that happens in life.

The endowment effect and loss aversion.

These are two biases that emerged in behavioral economics (h/t Kahneman and Tversky).

Without getting too technical, the endowment effect is a bias where we value something more if we own it than we would if we didn’t. Let’s say I gave you a bar of chocolate (how generous, right?). If someone offered to buy that bar of chocolate from you, the price you’d want for it would be significantly higher than the price they’d be willing to pay.   

Loss aversion is a phenomenon where people will take more risks to avoid losses than we would to achieve gains. More simply, losses loom larger than gains. Even more simply, we hate losing more than we love winning.

What does this have to do with buying stuff?

First, let’s admit that everything we own will, at one point or another, break. Our cars, our clothes, our phones, they’re all material and WILL need to be replaced.

Let’s say I bought a brand new watch.

As soon as I put the watch on and leave the store, that watch loses a chunk of its value. After all, it isn’t new anymore.

Because I now own that watch, I place more value on it than it’s actually worth (the endowment effect). The more time I spend with the watch, the more memories and experiences I associate with it, and the more value I place on the watch.

Now, remember, losses loom larger than gains. Even though I’m enjoying that watch’s sleek features and the benefit of being on time for meetings, I feel disproportionately more pain with every scratch or dent that comes with normal use (loss aversion).

Psychologically, the pain I feel when using the watch far outweighs the benefits I get from it.

I call this the Zone of Disappointment.  

I’d feel the Zone of Disappointment when that watch breaks. We feel it when our car is wrecked. We feel this pain with every item we buy.

The question that we need to answer: Is this “thing” important enough to me that I’m willing to stomach the pain of owning it?

When you spend money, you destroy your defense.

I’ve written about F-You Money before, but here’s the Spark Notes version.

F-You Money is a cash and investment cushion that buffers you from risk. It’s more than just an emergency fund – it’s 6+ months of expenses that you have on hand for when life gets tough. If the economy tanks and your job is on the line, it allows you to focus on doing your job rather than focusing on what you’d do if you lost your job (with the added benefit of making you less likely to lose your job since you aren’t focused on losing it).

Wasting money on stupid stuff erodes our defense in two ways. First, every dollar we spend is a dollar that we don’t have protecting us. Yes, we do have to spend money on living expenses other essentials, but that’s not the issue. Going over the top on wasteful things like dining out or owning an expensive car soaks up resources that could be used for defense (building a rainy-day fund) or offense (taking a low paying job at a high-growth startup).  

Second, every increase in regular spending (e.g. moving into a more expensive apartment) also increases the amount of money we need in case of emergency. If I move into an apartment that costs $100 more per month, I need an additional $600 in my rainy-day fund.

I don’t have a problem with spending money, I have a problem with spending money on things I don’t value and don’t bring me value.

By spending consciously, I can adapt to new opportunities and be ready for when life gets tough.

I know money can be a sensitive topic, but that makes it all the more important to talk about. Money isn’t an end – it’s a means. We can use it to buy our freedom, or we can use it to buy our chains. I don’t value money for what it can by, I value it for what it can create.

We have to decide what we value and (literally) put our money where our mouth is.

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