The way you think, and the way you feel; these two factors are creating your current financial reality. They can lead you to the land of peace and honey or leave you debt-laden and stressed. It’s easier to see when you are looking at someone else’s life. So I will tell you the stories of Alice and Sam.*
Emotional gratification + Sale = Debt
Alice has a killer sense of style. She’s out shopping and sees the world’s cutest shoes. They happen to be on sale! She tries them on and they are magic. She knows if she doesn’t buy them today, someone else will and they will be gone forever. She doesn’t have the cash, but she gets paid on Friday. So. she decides to use her credit card to buy the shoes now, and she tells herself she will pay off the purchase when she gets her paycheck. It’s this thought process that creates almost all credit card debt.
Let’s dissect what happened. Alice went shopping when she didn’t have any money to spend. On the surface, it can look like she might be shopping for something she “needs.” But I’m going to be bold and say it was for emotional gratification; buying things feels good. Second, “sales” evoke two things; a feeling of getting a bargain, which is very alluring, and the feeling of loss. “If I don’t buy this today I may never get it!” These two thoughts collectively propel her to pre-spend her income. This is the genesis of debt, because life has unexpected expenses. That’s a guarantee! “Something” will always come up. If you start entertaining the thought of pre-spending your income, it’s just a matter of time before you accrue debt.
Winning scenario
Alice: “I feel like I need a pick-me-up, but I don’t have any money until I get paid on Friday. I’m going to take myself shopping on Saturday. I’m going to cash my check, and take $100 in cash with me. I am going to buy whatever the heck I want, but I’m going to leave my credit cards at home. Otherwise, I know that my $100 budget can easily become a figment of my imagination. As for today, I’m going to call my BFF and chat it out.”
In the end Alice still gets the shoes, but she doesn’t pre-spend her income, so she doesn’t create debt. She also “plays the player.” Translation: she knows herself! The part of her that desires instant gratification isn’t going to stop at $100 if she isn’t forced too. Leaving the credit cards at home is the easiest way to ensure she doesn’t overspend her budget. But the biggest thing of all is that she is delaying satisfaction. This is the essence of investing. Giving up a little today for a lot tomorrow.
Fear in a falling stock market + 410(k) = Locking in a loss
Now maybe you are one of the few Americans who doesn’t have credit card debt and that example leaves you flat. Here’s another one.
Take Sam. She’s a cool cat who doesn’t like to take a lot of financial risk. In 2008, she was watching her 401(k) get pummeled, and, by 2009, it lost half its worth. The process was gut-wrenching. So, she sold everything.
Let’s analyze what happened. Fear caused Sam to sell. That’s pretty obvious. But why this is so devastating financially is if you lose 50% of your investment, you need to earn 100% just to get back to even. (Example: If you have $100 and lose 50%, you now have $50. To get back to your original $100 you have to earn 100%, or $50, to become $100. You have to double your money for that 100% return.) What I’m trying to illustrate is that emotion led to a thought: “Sell.” And that locked in the loss. This could have been avoided.
Winning scenario
Sam: “It’s 2009. My portfolio had decreased by half. I am scared I’m going to lose it all. I am not sure exactly what I’m invested in. I am going to find someone who understand investments and tell me what I have, and they can recommend a course of action.”
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