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Money Matters - NPX Newsletter Winter 2019
By Anthony Menches
There are a large number of books and blogs and articles that tell you what you should do with your money but they lack an explanation of why you want to save and invest your money. These writings generally use math to prove to you that what they are saying is correct. Mathematically, they are correct. Money compounds over time and that compounding effect is significant. Compounding is so significant that after a little while compounding on the money you have already saved adds up faster than any new savings you can add to it. This means that saving the first $1,000 is harder than saving the second $1,000 and saving the first $10,000 is harder than going from $10,001 to $20,000 in savings. If you can have a nice car today, then why would you forgo the new car and replace it with savings and investing? Why would you want to save that first $1,000 let alone the second? This is the quintessential question of personal finance. The answer boils down to happiness and how money can or cannot buy happiness.
Hedonic adaptation is the first concept to delve into and it is similar to those math articles of why you should, or in this case shouldn’t, do something. Hedonic adaptation helps explain why money can’t buy happiness as it is “a theory that proposes that people return to their level of happiness, regardless of what happens to them.”1 It basically just says that we get used to things, which is highlighted in this quote from Jean Jacques Rousseau in his Discourse on Inequality published in 1754, “Since these conveniences by becoming habitual had almost entirely ceased to be enjoyable, and at the same time degenerated into true needs, it became much more cruel to be deprived of them than to possess them was sweet, and men were unhappy to lose them without being happy to possess them.”1 Not only do we get used to things, we come to expect them as part of our normal every day. The more things we buy, the more we expect. Once we expect these things every day, they don’t even make us happy anymore. A daily $4 Starbucks five days a week is $1,040 a year. A new $51,000 Infiniti Q50 at 3% interest for 6 years is $775 a month or $9,300 a year. After a while, all that money is spent on expectation and not on happiness.
Hedonic adaptation has even been written about in other ways like this article that shows the salary at which earning more money doesn’t bring any more happiness, and it’s broken down by state. Ohio sits at a peak happiness salary of $70,500 per year. What does all of that mean? It means that once you have the basics of life covered be extremely judicious on what you spend your discretionary money on as it isn’t likely to bring you any more happiness, but it can definitely make you unhappy. If you only spend on things that really bring you joy and skip routine purchases of convenience, you will have more money and more happiness. This doesn’t mean you should skip all convenience purchases. Instead, you would want to limit them so you don’t start expecting it as a normal part of your day. You will also enjoy those rare occasions much more as you are not adapted to the presence of whatever item it happens to be. To revisit our earlier examples, a daily Starbucks brings no happiness, but a Starbucks every other week can remain a novelty and save you over $900 a year. A used 2014 Infiniti Q50 with 120,000 miles for $14,000 at 6% interest for 4 years would cost $329 a month or $3,948 a year, a savings of $5,352 each year! More importantly, you won’t see any happiness change between the two purchases. So why is hedonic adaptation bad for us? It inhibits our ability to achieve financial independence.
Financial independence gives you choices and choices bring you happiness. Do you want to take a year off of work to travel? Do you want to switch careers, but the new career is a lower paying position? Do you want to work part time or become a stay at home parent for your child(ren)? There are myriad similar questions but the general theme is that if you answered “yes” to any of these questions or any questions like them, you need to have your financial house in good shape in order to take action. Becoming financially independent gives you the ability to say yes when you want to say yes. In other words, financial independence is the ability to do what you want to do or what you feel is the right thing to do without having to worry about the impact on your finances. Becoming financially independent should be a goal of everyone because it allows you to say “yes”. You can take advantage of opportunities other people can’t, you can follow dreams without hesitation, you can dictate circumstances, ask for raises, or work on projects that truly matter to you all because you bought your freedom first. You can determine what makes you truly happy and you can follow that path without fear. Is there any better reason than that?
What we know is that spending more money doesn’t make us any happier and the biggest part about personal finances isn’t about what to do, but rather why you want to do it. For many of us, we won’t make drastic changes without figuring out our Why, but once we have determined our personal Why and what we want our future to hold, then we can make positive strides towards achieving that outcome. The answer to the earlier question of why save that first $1,000 is different for every person. That’s the reason why we call it PERSONAL finances. We should all take some time to reflect on what we value most and find our Why.
