The Financial Traps Awaiting the Professional and How to Overcome Them –Part 2

When you begin setting goals for early retirement, learning how to view money becomes one of your biggest advantages. I find the following perception shifts were helpful to forego immediate excess spending for future financial freedom. The first 3 concepts apply to combating the Delayed Gratification trap, while the last concept applies to the Societal Pressures trap mentioned in our Part 1 post.

Viewing a Purchase Against Its Potential Future Value

It’s very easy to view money spent as just another $100 meal or dress. $1000 spent on jewellery may just be a day’s work for some professionals. A $100,000 luxury car was less than one year’s work for many as well. With the insight that comes from the power of compound interest growth, the decision to spend becomes a bit tougher. In 30 years’ time, here is what each purchase could have been:

the $100 would have been worth $1000
$1000 would be worth $10,000
$10,000 would be worth $100,000
$100,000 would be worth $1 million
(The above assumes 8% annual compounding for 30 years and the actual calculations show slightly higher growth than x10 but I rounded down to keep the numbers simple)

There is a dedicated post to discussing compound interest and its magic, but this factor of 10 growth is very real and easily achievable. To think for every $100K you save, it provides your future self with $1 million to spend is quite empowering. The challenge with spending is that you will only be able to save $100K when you believe that saving $10 to become $100 is just as meaningful.

Stop Viewing Money Based On Your Daily Earned Income

Most frivolous purchases seem more justified after a long day at work. You tell yourself you deserve it since you have worked hard. “I made $1000 so spending $100 is nothing” is likely something you have thought before. Unfortunately, you are actually deceiving yourself in this line of reasoning. You are choosing to ignore that $400- $500 of that income fell out of your pocket when you left work that day. As a professional in a high tax bracket, your take home pay is much less then it feels.

If you adjust your spending reality to an annual cash flow being 50% less of what you traditionally believe it is, it will put many purchases in perspective. The fancy investment terms for this would be viewing spending in relation to net income versus gross income. Once you begin tracking your budget and expenses, you can take this one step further. There are numerous expenses that are not optional like shelter, food and clothing. Once the core expenses are removed, your extra cash available to spend will look even paltrier. Now the $100 purchase is accurately put in perspective by acknowledging that only $200-$300 is available to spend out of the original $1000 you earned. You may still decide to proceed with the purchase, but at least you are being more intellectually honest with your financial ability to spend.

Evaluating Wants vs Needs 

We all need to spend money; it’s unavoidable. My family spending has definitely grown since the beginning of our careers. Having children creates a whole new spending stream and child care is expensive in major cities across Canada. It always feels like something new pops up every day that takes a few more dollars out of your pocket unexpectedly.

When your house needs a light bulb, you clearly need to buy a new one. Living in darkness is downright primitive. Yet you don’t have to replace it with a golden chandelier to achieve your goal. This is a facetious example, but I would submit that the cost of your clothes, cars, and kitchen counter tops may be beyond their functional requirement. Acknowledging when you are actively making a want vs need decision is important. I’m not going to say never spend beyond what you need. I have definitely made my fair share of extravagant purchases over the years. In these situations, I have insight into the extravagant desire and I have weighed the excess cost compared to my financial circumstance at that time. Unfortunately, I believe many people will consider a frivolous want as actually an essential need irrespective of their financial circumstance.

Once the three above money psychology perception shifts are combined together, adjusting your spending to delay gratification further down the road will seem much easier. It will help set off a savings cascade to place you on the financial independence path in no time.

4. The Inner Score Card

There are numerous blogs that talk about maximizing thrift to achieve financial independence for the average person. My personal favourite is Mr Money Moustache, which has become quite popular. I strongly encourage readers to check it out and read the “Start Here” link along with posts right from the beginning of the blog in the archives. The blog’s ethos is that much of the excess spending in North America does not lead to excess happiness. It suggests your happiness will increase substantially once you live simply and become financially free quite quickly as a result. The blogger was actually able to retire by age 30 after saving over 60% of his family’s annual income.

His blog should make you feel quite empowered. Many individuals following his frugal path are achieving financial freedom within 10-15 years of work. These readers achieve this with dramatically lower earning power than you as a professional. I found the lifestyle adjustment that was proposed in his blog to be quite a dramatic shift from my lifestyle, even though I already am “spending-cautious” relative to my peers. I couldn’t imagine myself not driving, travelling or cutting costs quite as low as him. I haven’t adjusted my lifestyle to mimic such a simple life and am not suggesting you will need to decrease your spending that significantly to achieve your financial freedom. However, the concept derived from the blog is very meaningful. I found it incredibly impressive how the blogger stuck to his principles despite many around him balking at his minimalist lifestyle.

Our upbringing and societal views during our youth will have significant influence over our values and principles. I grew up in an upper class setting where signs of wealth and extravagance were quite apparent. I would see adults competing over nicer cars and homes all around me. I am personally quite competitive by nature since I was a child, whether it was school, sports or board games with my sisters.  My competitive nature would push me to think showing your wealth was an important part of being considered a success. As time went on though, I began realizing that many of these people did not seem truly happy. I was then introduced to a concept by Warren Buffet in a book called “The Snowball: Warren Buffet and The Business of Life” by Alice Schroeder. It is easiest to quote directly from the book regarding the concept of the Inner Score Card.

The big question about how people behave is whether they’ve got an Inner Scorecard or an Outer Scorecard. It helps if you can be satisfied with an Inner Scorecard. I always posed it this way. I say: ‘Lookit. Would you rather be the world’s greatest lover, but have everyone think you’re the world’s worst lover? Or would you rather be the world’s worst lover, but have everyone think you’re the world’s greatest lover?’ Now that’s an interesting question.

Here’s another one. If the world couldn’t see your results, would you rather be thought of as the world’s greatest investor but in reality have the world’s worst record? Or be thought of as the world’s worst investor when you were actually the best?

In teaching your kids, I think the lesson they’re learning at a very, very early age is what their parents put the emphasis on. If all the emphasis is on what the world’s going to think about you, forgetting about how you really behave, you’ll end up with an Outer Scorecard.”

After reading this, it solidified a concept that had already been brewing within me. I felt greater resolve and internal strength when I chose to live my life by principles that were formulated solely by my values and beliefs. Many of these values fit with conventional societal views, but many did not. I began firmly believing that having financial independence was far more important than any demonstration of external wealth. The concept of worrying what others thought started melting away. My confidence grew as we made progress on our short and long term goals. It was a self-perpetuating positive feedback loop that has left me unable to revert back to the previous external wealth mindset that pervaded my youth. The Inner Score Card is a very valuable concept. We will always have an Outer Score Card that we judge ourselves on – it is part of human nature. Yet if we choose to evaluate the most important areas of life that contribute to true happiness via the Inner Score Card, it is hard to see how it won’t be helpful to us in the long run.

Do you use any of these psychological tricks? Do they seem like they would help? What holds you back from making changes in your spending habits? Comment below as I’m interested in the perceptions of spending that everyone has.

Our next post will describe another important trap that affects our ability to save as well as a core tenet of financial planning to help you combat it.

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2 comments On The Financial Traps Awaiting the Professional and How to Overcome Them –Part 2

  • Great post! Thank you for this, this really made me re-evaluate why my husband and I (30 something doctors in Calgary) still don’t feel financially secure. What are your thoughts on quickly paying off mortgages (with double up payments/large yearly lump sums etc) vs using that money to invest? We go back and forth as I think it makes more sense to quickly pay down the house, but my husband thinks we should take advantage of current low mortgage and interest rates and invest that money or at least keep it in our Corp. Would love to hear your thoughts on this!

    • Hi Ambi,

      It is a great question and I actually have a post for publishing in the near future entirely dedicated to the question of early debt repayment in either student debt or primary residence vs starting a retirement portfolio in the corporation.
      There are a lot of variables to consider which I will discuss thoroughly in the future post, but the 2 main ones are:
      a) expected investing returns as a %/year – this is highly variable to predict in the short term, but longer term you should expect 5-8%/year depending on your asset allocation strategy (conservative, balanced or aggressive)
      Keep in mind we have just experienced an ~8 year period of generally positive returns without much of a market correction. Therefore in the short term, anything can happen.

      b) cost of servicing the debt as a %/year – this is at historical lows and likely your mortgage or student debt is in the 2.5-3.5%/year.

      Generally speaking, if you can achieve a higher LONG TERM return than what it costs to service your debt than it would be more beneficial to invest. The difficulty is your debt payment is a guaranteed “return” of 2.5-3.5% on the money you allocate to it, but the investment returns are short term unpredictable. You may put $100,000 in investment just to have it drop 10-20% in a year and then you would feel mad you didn’t just pay the mortgage down.
      But if you view, the $100,000 as purely for long term use in >25 years, it should be very reasonable the investment should beat the current 2.5-3.5%/year.

      I think having the tax deferral via the corp adds to the investing advantage and will talk more about that in future posts. Hope that helps!

      FFMD

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