Personal Finance
Tuesday, August 26, 2008
Caught this talk about Personal Finance while surfing the web.
This issue has been constantly on my mind - passive income more than active income, finishing the rat race, how to run my own race and finish it my way.
You can catch it at
http://sgmusicwhiz.blogspot.com/2008/07/personal-finance-part-9-parkinsons-law.html
or right below
Personal Finance Part 9 - Parkinson's Law, when "Wants" Become "Needs"
I've recently begun reading more about Personal Finance, thanks in part to Panzer's blog and also my increasing thirst for knowledge about how to become financial independent and to escape the rat race. Interestingly, as I read more and borrow books on personal finance, my desire to break free from the rat race becomes more evident and more pronounced. After all, the idea of financial freedom is to be able to do what you love without being burdened by the idea that you NEED to work. In other words, you can literally fire your boss and live off your passive income until a ripe old age - assuming your lifestyle does not change.
But the crux of this post is that people's lifestyles DO change, and Parkinson's Law is a little known pehnomenon which helps to explain this. The original Parkinson's Law dealt with work and time with the saying: "Work always expands to fill up all available time". This simply means that the less work you have, the more you seem to wrap your time around the amount of work given to you; while if you are given more work, it simply fills up all the time you currently have, making it seem as though you never have any "free" time at work ! This law can also be applied to personal finance by re-phrasing it as such: "Expenses rise to fill up all available income". What this means is that as one gets wealthier, one's lifestyle also changes to accommodate the rise in income, such that one's saving ability is the same as before the increase in income.
This phenomenon is extremely pervasive and prevalent in our Singapore society, and I see this being manifested in many people (friends included) from all walks of life. As one's salary increases (over the years through job hopping, promotions or increments), one also tends to scale up one's lifestyle and spend more. In other words, a person earning S$2K a month has a lifestyle which accommodates his S$2K salary; while a person earning S$8K a month will adjust his lifestyle upwards (more branded goods, more expensive restaurants) such that he will be spending the same proportion of his income (as a %) as the guy earning S$2K (heck, sometimes the proportion is even more !). This makes it very hard for the average person to build wealth because he is consistently and persistently spending away his excess income.
This effect is psychological - many people are of the idea that they "deserve" a better lifestyle since they are now earning more, so why should they "deprive" themselves of the comforts and luxuries of life ? While this argument is sound, many of the youth these days tend to over-indulge in these "pleasures" to the extent that it becomes a NEED for them to have certain luxuries (rather than being just a WANT). When one confuses NEEDS with WANTS, then their spending is apt to go haywire and they will be unable to save enough money for investment or retirement. For example, an iPod is a WANT and an iPhone is a WANT but many young adults these days cannot live without these devices. Similarly, a car is also a WANT for many people (excluding those in sales line or with infirmed elderly or very young children) but many indulge in the almost zero downpayment requirement and get one as soon as they earn a salary.
Hence, this downward spiral will start to occur when one falls victim to Parkinson's Law. I have heard of couples each earning S$6K a month who buy a condo worth S$900K or close to a S$1 million and a car as well. They take out 30-year mortgages and work their butts off to pay their liabilities; not realizing that such leverage is risky in that one small incident (e.g. a layoff or retrenchment) can cause much financial distress. This leads to the saying that "it's not how much you make, it's how much you can keep" which matters. A person can be earning S$10K and saving just S$500 while another earning S$3K could be saving as much as S$1K a month. Some people who earn a lot also may not have safety nets such as insurance and/or passive investments such that should they lose their job, they have zero sources of income to fall back on. With a high liability lifestyle to fund, this would make the situation even more dire. The buzzword these days is "quality of life" which basically translates into spending a lot of your income just to keep up with the Lims and Tans, the way I see it.
So the way to beat Parkinson's Law is to be acutely aware of it and its insidious effects. There is nothing to say you HAVE to scale up your standard (and cost) of living once you start earning more or getting a promotion. If one consciously controls his urge to spend more and instead falls back to his usual routine, then one can still feel happy because most WANTS are fleeting and the pleasure that they give is momentary. For myself, I have been consciously tracking my spending (cash and credit card) monthly over a couple of years to ensure I do not start spending more even though my income has increased over this time period. In addition, I also measure myself against my total net worth (assets minus liabilities) instead of using total income so that I can see a positive relationship over time (increasing net worth). This motivates me to build more wealth by reducing my liabililies gradually and also growing my sources of active and passive income.
posted by ikaira @ 12:18 AM,
