It’s hard to believe the summer is almost over and kids will be going back to school soon. A few weeks ago I bought my son new school uniforms for the fall. There is one store in the area we have to buy them and they have few sales, so I make sure to go in June for the 10% discount. Even with the discount I ended up spending a few hundred dollars on everything we need. Feeling poor I then bought myself a fast food lunch and paid in quarters. Soon after that I realized I also needed to purchase a new soccer uniform for him and then both kids will also need new shoes. Oh, and the balance is due next week for our annual beach vacation. Of course this all came at the end of the month. These kids are bleeding me dry!
Bottom Dollar Effect Explained
Having just spent a significant amount on items for my children, it’s easy to feel like that is where all of my money is going. This actually has a name. It’s called the “bottom dollar effect,” and it is the tendency to attribute more satisfaction to purchases made when your bank account is flush than those made at the end of your budget or when your financial condition is not perceived to be as strong.
Research at the University of Arkansas “demonstrated that consumers experience significant differences in satisfaction based solely on their budget status or financial condition at the time of purchase, rather than the quality of the product or how much it costs.”
While these findings have significance for companies that market directly to consumers, they are also another element of behavioral finance for long term investors to consider. Knowing that we attribute more pain to cash outflows on a dwindling bank account can further blur the lines between what is a true expense and what is an investment in our future financial independence. For example, it’s easy to justify that you “can’t afford” to fund your Roth IRA contributions or increase in your 401k deferral because other expenses are higher priority. Flipping your budget upside down and implementing a pay yourself first strategy can combat this counterproductive behavior.
Keep Attention on Savings
Chad quoted Morgan Housel in a recent podcast that really illustrates this point, “Every bit of savings is like taking a point in the future that would have been owned by someone else and giving it back to yourself.” This is a great way to think about your savings strategy. Sometimes I’ll also use the example of moving money from one pocket to the other for funding account contributions. Unfortunately, many investments are not as straightforward as shifting funds from income to assets. Many times investments can be disguised as expenses and vice versa. Some common examples of this are:
- Monthly Mortgage Payments
- College or Graduate school tuition payments
- Student Loan Debt
- After Tax Contributions to a 401k
- Financial Planning, Tax, or Legal Services
- Home Renovations and Improvements
Even in my example of school uniforms I know that buying the uniforms at a discounted rate in June saves me money over the course of the year since I likely won’t have to buy him much more in the way of clothes and sending him to a school that requires uniforms also eliminates the desire for specific brand name clothes that the other kids might be wearing, saving money and headaches. And while uniforms are necessary, it is a public school, so we are also not having the much larger outflow of private school tuition.
While I know all of these things, my gut reaction was still to be disgusted with spending that much money on the uniforms. This is why it always helps to step back and take a look at the big picture. It’s very easy for our emotions to deceive us and this can be hazardous to your wealth. Putting these investment/expense decisions in the context of a holistic financial plan can be invaluable in sticking with your long term savings and investment plan.