When trying to achieve financial independence and retirement in the current macroeconomic circumstances, some people will make purchases that deplete their portfolio of capital. This can be the onset of bad spending behavior.
How Should We Classify Bad Spending Behavior?
A lot of people think bad spending behavior only happens when you have no financial education or knowledge about budgeting. This isn’t true. Bad spending behavior is often categorized as spending out of your means or with no plan, and it can happen whether you’re in debt or financially independent.
This behavior can also be categorized as shopping for a source of entertainment, impulse purchases, or overspending on common items.
Simply making more money won’t solve bad spending behavior. And poor decisions can happen even if you take the time to educate yourself and make an effort to manage your money wisely.
There are ways to combat bad spending behavior, but the methods are typically learned instead of innate and are often contrary to commonly held cultural views.
Spending a bit occasionally shouldn’t be categorized as bad spending behavior because everyone spends a certain amount of money every now and again for pleasure. The key is to keep this spending under control, so that it’s not taking over your life.
It’s okay and even encouraged to leave yourself some room for luxury spending while targeting your money goals. Consider the 1% rule for spending on luxury, augmented based on your salary.
Giving in to Consumerism and Spending
The forces of consumerism and materialism can be powerful and may cause one to fill their life with clutter and unnecessary spending. Less is more when it comes to personal belongings, whereas some people feel that over-consumption is required in order to be happy.
The key point here is that to correct bad spending habits, you should live below means and not just lower spending. You’ll also want to avoid debt as much as possible in order to preserve capital for retirement or other goals.
Companies feed into consumerism. While some tactics that companies use are more obvious than others, companies typically do little things intentionally to boost profits and increase the amount of money they get from each customer.
In a lot of cases, big banks have literally made up entire industries that exist for no reason other than to take money out of your pocket. This seems especially true in any industry where companies charge a lot of fees or spend most of their effort convincing you why you need their product.
For example, credit card companies charge interest rates up to 30% on purchases while offering rewards programs that give points worth about 1% back (for cash back cards). However, if you’re not carrying debt, taking advantage of points and cash back credit cards will help you save.
Advertising costs banks millions, but advertising has the power to influence your buying decisions. Banks are therefore able to make money from you regardless of whether or not you take out a loan. It doesn’t matter if you are just a customer without loans or are an extremely loyal customer – banks create business models that allow them to profit from their customers with only little risk themselves.
Marketing and advertising has evolved over the last century with the emergence of major technologies and innovations such as television and the internet. As each new technology emerges, it transforms the way companies market their products and services.
Even small businesses need digital marketing, and its advent has made marketing much more complicated than simply buying an ad for your store or product in the newspaper or local TV channel.
The internet especially changed all of this by making online marketing more accessible. With access to millions of unique users at any given time, advertisements can be placed in front of targeted customers for pennies compared to traditional forms of advertising such as print and TV ads.
The emergence of social media has created even more opportunities for businesses everywhere, giving rise to a whole new industry known as social media marketing (SMM). All of this advertising surrounds us on a daily basis and permeates into a culture of consumerism.
Being Unaware of Your Psychological Biases
Behavioral finance is not just about how to maximize returns; it’s also about understanding what drives bad spending and investment decisions, as well as the psychology surrounding why we do some of the things that we do as consumers. Understanding and learning about our biases can help us invest smartly and make sound decisions.
I was taught that if you wanted to make good money decisions as an investor and as an individual, you had to understand risk. If you understood the different levels of risks in investments then you could make better decisions about what level of risk is appropriate for your situation based on your goals and objectives.
I learned that most people are loss averse – when we take a loss, we feel it more than when we take a gain of equal magnitude, and this irrational reaction to losses has huge implications in terms of our spending and investing habits. It means that if you had $500, and saw it drop to $475, you’d feel a lot worse than if you had started with $100 and doubled your money to $200.
Loss aversion can have huge impacts on people’s actions, such as in investments in real estate and precious metals when it comes time for investors to take their gains or losses, and in the decision of whether or not to sell a stock.
When you start talking about real estate and precious metals investment, loss aversion has an even larger impact on deliberations. “Buy low” is halfway between a truism and a cliché for investors; there’s little question that it’s always better to buy something that’s been beaten down in price than it is to buy something for the first time when it’s expensive.
The problem with this decision-making is that many people will see prices climb up and get greedy, or more accurately they’ll be subject to a phenomenon known as “recency bias,” which causes us to think of events most recently experienced as being far more likely than they really are going forward.
So when something is low, investors get greedy and jump in; when it’s high, they sell out.
Our physiological biases can lead us into making bad purchases, bad investments, and overall bad decisions. Learning about common biases before investing can help you avoid common mistakes.
How Does Your Temperament Affect Spending Behavior?
Most people belong to a certain temperament group. While changing your temperament is not always possible, knowing what drives you can help you change your habits for the better. Greek philosopher Socrates famously said, “To know thyself is the beginning of wisdom.”
As such, to make a change in your life, knowing where you stand can help you orient your next steps. The four most common groups of temperament are cholerics, melancholics, phlegmatics, and sanguines.
Cholerics are passionate, energetic people who tend to be strong-willed. They are “entering” types. They are characterized as loving new experiences and challenges. Choleric people like excitement, competition, challenge, action, variety, and change. They are generally upbeat but can have mood swings where they go from being very happy to extremely angry in a short amount of time.
Melancholics can range from quiet, brooding introverts to dramatic extroverted depressives. Their temperament is marked by a tendency toward concentration and contemplation rather than action. They are “reflecting” types whose extreme sensitivity leads them to focus inwardly, feeling everything deeply in contrast with their outward appearance of calm self-control.
As sensitive as they are, melancholics also tend to be perfectionists who demand a great deal of themselves and others. Often creative, melancholy temperaments prefer activities that allow them freedom of expression such as writing or music and do not like mundane chores or routine tasks.
Phlegmatics are easygoing and undemanding. They adapt well to new situations, and are optimistic and easygoing with a live-and-let-live attitude, which often leads them to be exploited by others. They tend to be conventional and place high value on public opinion; they can easily change their opinions or be convinced by someone who seems self-confident to agree or do something without necessarily believing in the merit of that course of action.
Sanguines are easygoing, pleasure-seeking people with good social skills and an outgoing personality. The sanguine temperament is marked by optimism and enthusiasm in most situations. Sociable and gregarious by nature, sanguines make friends easily and usually have large networks of family members and acquaintances from all walks of life. They tend to be on the go, and are well-coordinated.
When it comes to bad spending behavior, your temperament can be a factor. For example, cholerics might be more tempted to overspend on entertainment because rapid spending gives them a thrill. There’s also some evidence that people with emotional instability, materialism, introversion, and the need for arousal may be more likely to engage in credit card misuse.
Pessimists by definition tend to have lower self-esteem and believe they’ll fail at their goals, so it may be important for a pessimist to be extra mindful of reducing debt or sticking with a savings program.
How we perceive and cope with money can have a big impact on our overspending patterns, as well as our ability to save. Although getting your finances to do what you want might be tricky, it’s important not to feel overwhelmed by the task at hand.
Sometimes the change to correct bad spending behavior starts with yourself. Taking small steps and setting attainable goals will help you achieve your goals, even if you don’t believe it yet. As U.S. Army General Creighton Abrams said, “When eating an elephant, take one bite at a time.”
When you think about retiring, plan to save enough money to live a lifestyle that is similar to the one you currently enjoy – but not necessarily an extravagant one.
That means that living below your means can translate into retiring very early if you don’t increase your spending as your income increases over time. You are decreasing expenses as an expense floor when maxing out 401ks, IRAs, and HSAs.
Those who have achieved early retirement and those who succeed financially share some common characteristics. The following are a couple behaviors that tend to crop up in a lot of people who do not need to work for the rest of their lives, or at least don’t have to worry about money in their golden years.
Let It Ride
If you have been lucky enough to make a bundle from an early investment, let that thing ride. Some people who have success with early investments gradually sell off shares of stock over time as they find something new or interesting.
It is like watching a snowball rolling downhill until there is nothing left to watch roll down the hill. The same thing happens when you manage your portfolio conservatively on a day-to-day basis while never making big bets on anything other than cash equivalents (e.g., CDs, Money Markets, T-Bills). Don’t take unnecessary risks.
No Risk, No Reward
On the other hand, if you are investing for income then you should not have too much of your principal riding on any one investment. If you take a big risk with 20-30% of your portfolio in a single stock or bond, and you lose all of it, well…you just lost 30% of your wealth.
There is little reason to potentially put yourself in that position unless there is a high likelihood of earning more than 30% in the first place. Don’t be afraid to buy diversified funds.
How Do You Fix Bad Spending Behavior?
While financial independence is often touted as a major motivator for spending less, most people will still have the impulse to spend impulsively. You’re only human, after all. And like any addiction, it’s difficult to kick cold turkey. So, how do you cure yourself of this bad habit? It boils down to:
1. Change Habits
This typically involves doing something differently and developing new habits that are more conducive to your financial independence goals. For example, if you need help saving money on food expenses, consider buying in bulk and storing food in your freezer.
2. Find Support
Look to your social circle for help. If you’re surrounded by others with a similar mindset this should be easier. Research and learn, or consider taking finance courses to help you understand the basics of managing your own finances. You can also utilize lending software to help you keep track of your loans.
3. Change Your Mindset
This is probably going to be one of the most difficult parts if you’re looking to break free from consumerism. Those beliefs that you have about money, possessions, and self-worth were most likely instilled in you from an early age. It may have been reinforced on a daily basis by family members, friends, and teachers, and it likely took years before those beliefs became part of who you are today.
These beliefs are what keep you chained to the routine of your job and your office, so they will be hard to let go of. But all is not lost. You can cut down on needless expenses if you want to, and one of the best ways to do that is to make it harder to spend money.
Stop Comparing Yourself to Others
No matter how much stuff others may seem to have compared to you, there’s always someone with more than them. This cycle goes on across the social spectrum and beyond into the animal kingdom. You can’t let this affect your goals and how you perceive yourself.
Start a Financial Portfolio
You’ve heard of a 401k at work, right? A financial portfolio is exactly the same thing except you’ll be managing your own. It’s deceptively simple: put money into various things that give you interest and income, such as bonds or stocks. Your portfolio can also include investment properties.
The beauty of it is that unlike a 401k where you are limited to a certain amount every pay period with stiff penalties if you go over, a portfolio gives you something called “unlimited growth potential” because once you get started investing correctly and make some good returns on your investments, the sky’s the limit for your wealth.
Stop Wasting Time on Social Media
A huge part of achieving your goals is learning to realize what’s important in life. Instead of endlessly double-tapping your friends’ brunch photos or eroding your mental health by “doomscrolling” the latest global crisis, engaging in wholesome social media consumption that progresses your goals in limited amounts will free up your time and promote a better outlook overall.
Use Your Free Time Wisely
It’s tempting to spend a massive amount of time watching TV or playing video games that have no educational value whatsoever. Now, there’s nothing wrong with watching TV or gaming if it lightens the stress from the day, but losing out on productivity can be a detriment to your life goals.
Use some of that free time to learn about finances or anything else that could help you advance in your income generation and savings goals.
The Bottom Line
I can tell you that it won’t be easy, but if you take small steps, you can be well on your journey of correcting bad spending behavior. Stay focused on your goal, but don’t beat yourself up if you miss a step along the way. Your future self will thank you for making progress even if it isn’t as fast as you’d like.