Continuing from last week’s article on how credit cards are ruining your brain’s ability to acquire good spending habits, let’s talk today about how you can hack the Wealth Effect!
How wealthy you feel will have an impact on your spending habits.
Imagine first that you have $100 to your name. That’s it. You have nothing else on this earth to call your own other than $100 and the clothes on your back. You then get hungry. How are you going to choose to spend your money on food? Are you going to walk into the first restaurant you see and order a 500 g T-bone steak? Definitely not. You’re going to go to Aldi and buy a role of bread and some tuna for $1.20 …
Flip the thought experiment around now.
Imagine you have $100,000,000 in your bank account and you get hungry. Your options are limitless! You aren’t going to care about the cost of what you’re buying… You’re the head honcho! You just point and people bring you delicious things!
How does this apply to your everyday life?
While the above scenarios are extreme, they illustrate an effect which we all live with every day. It is called the Wealth Effect. Generally, for most Australians it has a detrimental effect. You have a home worth $1 million and then next year it is worth $1.2 million. So, you feel richer and spend more. This in some cases results in people spending more than they earn and so they get tangled up with increasing levels of bad debt. Your perception of your wealth is getting in the way of your actually being wealthy!
Rather than the Wealth Effect working against you, wouldn’t it be great if you could harness this power and turn it to good rather than evil? Becoming, in the process, a bit of a Super Saver?
In fact, you can. What you need to do is make yourself feel poor! The poorer the better. What this will do is kick your brain into a survival saving mode and allow you to save a large percentage of your income without having to constantly test the bounds of your discipline. To achieve this you have to do the following:
Save first. Spend second. You allocate how much you are committing to save into a black hole savings account. This account should not be linked to anything you can see online. Once money goes in it never comes out, unless it is being invested. If you can begin an investment strategy then even better, as it will be harder to get these funds out. Then what you have left over is your spending money for the month or fortnight. After bills come out you might only have a few hundred dollars in this account for the fortnight. This will constantly be in the back of your mind and this scarcity of money will keep you in line.
Get rid of all of your credit cards and easy access to bad debt. The first step above is meaningless if you are using debt to fuel your spending. You may now be thinking, “But what about all the great points and benefits! Can’t I just keep one card? Just for old times’ sake?” Having even a small limit of $5,000 will have an impact on your spending. Your brain basically does this. “Hmmm I have $300 in my account plus a credit card limit of $5,000… so I have $5,300 available to spend!” This will ruin the feeling of scarcity and then you’re back relying on good old will power to save and that is a tiring uphill battle…
Forget about the idea that your home is an investment. Your home is not an asset. It is a liability. An investment property is an asset as it generates you an income, however, your home COSTS you money, even if you have no debt on it. Just because the value of your home doubles, this doesn’t make you any richer. To realise the value increase in your home, you would have to sell your home. Where will you then live? You would need to purchase a property in a different city where the market had not appreciated to the same degree in order to have any leftover cash. For most people this is unrealistic. So banish the value of your home from your thoughts!
In order to be rich, you must first feel poor!