
This is a concept that is crucial to understand if you are to enjoy freedom in your life. As I wrote on a number of occasions, managing your financial resources is a vital part of this quest. The majority of society throws away their freedom one decision-at-a-time. Their slavery is insured by each transaction. Most fail to understand the concept that it isn't what you earn but, rather, what you spend that matters.
Impulse Buying
The first thing that absolutely destroys people is the urge for instant gratification. This often comes in the form of impulse buying. A person sees an item and he or she just 'has to have it'. It is as if life will cease to exist if one fails to make this purchase. My experience dictates that nothing is of this epic proportion. The truth is that your life will continue if you do not make a particular purchase.
Impulse buying is what provides the marketers with all their power. People do not realize how they are enslaved simply by their actions in a store. Have you ever noticed how great consideration is given to how things are displayed? This starts with the design of the packaging to how things are placed in a store. All efforts are taken with the intention of creating an urge within you that needs satisfying.
This is what leads to the impulse buy on your part. Items that fall into this category of purchase are not planned. One only makes a decision to purchase after receiving the stimulus in the store. Sales are one of the most popular methods utilized. One understands that he or she doesn't need the item yet the idea of passing up the opportunity to save 75% is just too much. This is the classic example where the unenlightened person thinks 75% was saved when the truth is that 25% was spent.
Diminishing Returns
The next part of this idea is that concept of diminishing returns. What this basically means is that you will not want the particular item as much as you want it when you are in the store. Over time, the return it provides in terms of your desire lessens. Most of us have experienced this in one form or another. Think back to a time where there was something that you 'just had to have'. What happened when you got home. In many instances it was put into a closet only to be left there for months (or years). Your excitement for the item waned.
Getting back to our example, this is how one can spend 25% instead of saving 75%. If an item is not needed, and is ultimately not utilized, then money was wasted. Nothing is for free. Even though the item was on sale, the cost advantage did not outweigh the rapid decline in returns. The diminishing return factor hit immediately upon arriving home. Every day people model this same behavior. Avoiding the diminishing returns by resisting impulse purchases is one step to financial freedom.
Familiarity
The other aspect where diminishing returns enters into the picture is with the idea of familiarity. Applying this idea to purchases will enable one to save substantial sums of money. Again, most people fall into the trap of paying extra for something that will soon be familiar.
To explain this concept, I only need to point to how people take things for granted. When something is new, we appreciate it (in some instances). However, the longer we have the item, i.e. the more familiar we are with it, the less we value it. We simply take it for granted. I suppose this is human nature which means we are all apt to fall into this. Therefore, it is crucial we know how this affects our purchasing decisions.
I will offer an example that we discussed recently while do our evening walk. We live near the beach but not on the beach. It is about a 10 minute drive for us. Of course, being beach lovers and people who enjoy the scenic view of the ocean, the mention of purchasing something right on the beach occurred more than once. However, it is quickly dispelled by this concept.
There are many people who buy on the ocean simply for the view. They like looking out and seeing the water. The same is true for people who are up in the mountains. People of this ilk like the panoramic picture presented each time they look out the window. However, most of them fall prey to the law of diminishing returns.
Here is why:
When something is new and unfamiliar, we are apt to pay the most attention. Thus, one will enjoy the view the most when he or she first moves into the house. As time goes by, the view becomes less noticeable. It is still there while presenting the same grandeur. However, the person's outlook changed. The scenery became so familiar that one hardly notices. Of course, this changes when relatives come by and mention the wonderful view. Then the home owner might give it a passing look.
The reason why returns are involved is because the is a financial price involved. When the house was purchased, monies were exchanged. And, when one opts for a beachfront property, he or she is paying a premium for the view. This is alright as long as it is appreciated. However, as was shown, once the view isn't enjoyed to the same degree, the person is left with the same inflated mortgage payment. Hence more money is paid for less in return.
To put numbers to this, I came up with a price of $250,000 for a beachfront condo versus $125,000 for a house in another area. While the numbers might not be accurate the concept is. Let us suppose these units had a mortgage payment of $2,500 and $1,250 respectively. Under this scenario, the owner is paying $1,250 for the view (I realize other factors might be involved in a purchasing decision but you will understand the point). This means our owner is spending $15,000 a year to experience the law of diminishing returns.
That is a healthy sum no matter how wealthy you are.
The Solution
How do we avoid this situation? The simply answer is to not purchase. Go with the lower priced alternative for one simple reason. Ownership always breeds familiarity. It is the nature of having something for a long time. When you see it day after day, it becomes the norm. Owning equates to the law of diminishing returns.
That being said, do you know what does not offer this? Renting. When one rents something, it doesnt have the chance to become familiar thus is apt to be appreciated to a greater degree. In our culture, this method is overlooked except in areas that do not seem to make financial sense (leasing cars is an example).
Getting back to our example about the beach condo, one could establish greater freedom by renting as opposed to buying. Now, please do not mistake that to mean long term renting since the same thing results as purchasing. What I mean is to rent a place on the beach for a short period of time to ensure the enjoyment remains high.
In our example, I could save $1,250 a month by opting for the lower priced property. With this money, I could save for a really nice vacation on the beach. In my area, I found a place I could rent for $1,200 a week. Thus, my week on the beach is paid for after only one mortgage payment. Financially I am freer since my mortgage is lower and I will appreciate the view because I only have it for a short period of time. A week is not enough time for the law of diminishing returns to kick in.
One final thought: I can do this every year if I desire while saving myself almost $14,000. The fact that I am able to control my emotions when making a purchase allows me to experience greater freedom in my daily life. As you can see, suddenly I can afford something that is typically reserved for well to do.
Remember this idea the next time you are faced with a purchasing decision.