Sunday, July 27, 2008

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.

18 comments:

la papillion said...

Hi mw,

Great article you wrote :)

I must highlight this: Needs and wants can change - your wants can become your needs and vice versa. Who is to say a holiday abroad (typically a want) cannot be a need?

Working might be a want too ;P

I guess wants and needs are tied down to lifestyle choices. We only have 1 life - it's up to us to decide how to best live it. Even lifestyle choices can change, haha :)

Life is complicated.

Anonymous said...

Always enjoy your posts... Here or in WS. But guess who ?? One hint: I save over 50% of my income. But the following thoughts may sound strange to you.

1.] Working can be a need too. So, while I aim to be financially free, I don't plan to retire until I reach 65/67.

I need to work because I want to "be useful". "Be happy & be useful" are the only two principles that guide my life and what I do.

2.] One has to strike a balance between spending & saving / investing, depending on his/her own circumstances.

If one saves too much and feels miserable, it is time to consider a change. And when he/she is old, he/she may not be healthy enough to spend (no good restaurant food, no travel, no this, no that)...

3.] I don't want to give my children a "poor man's children" mentality by living a very "cheap life". But, I emphasize often that it is "value for money" we are after, we are not after cheap things.

Keep up your high quality blog...Cheers..

Anonymous said...

Completely agree. I lived on the same lifestyle for over 5 years after I began working even though my income doubled in that 5 years. A big part of that was by not buying a car (nod to the previous anonymous).

What happened over the last two years was very different. My wants became needs when I became a father, and had to get a maid and a grandparent to take care of the infant. With the increase in household size I needed a bigger house. So suddenly I'm spending all I earn. It's tough, but parenthood sometimes cannot be measured in money. Money can be earned back, but your kid's childhood - you can never press the "rewind" or "replay" button. So it's been psychologically painful for me to see my net worth declining slightly (with bonuses it's still growing slowly), but then after all, I don't want to die with a big net worth and rotten children.

PanzerGrenadier said...

@Anonymous July 29: Agree with you. I am experiencing the same thing. Before my daughter was born, I could save 40-50% of my income. Once the baby came out, the maternity ward/medical charges, getting my set of wheels, maid etc. all kicked in and I am lucky if I can save 10% of my income now... Fortunately, my home is sufficient so I don't need to upgrade.

@La Papillion
Needs and wants are very individual choices. :-)

I think one has to balance between present wants/needs vs future wants/needs. But I still push myself very hard to save AT LEAST 10% of my income each month, i.e. to live within my means.


@Anonymous 27 July: It's great you are in a career where you see yourself working until 65/67. For me, I've tasted the fun of being a volunteer and being a toastmaster as after office activities and there's lots to do in these two areas to touch lives. But I need to be financially free to pursue those interests (and many others) e.g. learn Japanese, improve my mandarin etc.

@Musicwhiz: Wants becoming needs is very common as one's income level and tastes can change. For me, I try to manage it. For e.g. I didn't own a car until my daughter was born. Now that car expenses and petrol eat into my budget, I eat at home more because it's more economic for the family to have simple nutritious meals cooked at home. Save on dining out costs. What was previous a $50-60 dollar meal for 2 can turn into groceries for almost 1-2 weeks depending if you're buying more veggies or fish/meat!

PanzerGrenadier said...

@Musicwhiz

I am having a blog carnival over the national day weekend and would like to ask some of the thefinance.sg bloggers on their thoughts on this:

"What is the single most important lesson you learnt in personal finance?"

Would be great if you could drop me an email on this via rod.loh at gmail.com

I will credit all contributions back to your blog during the carnival which will be from 8 to 10 August (to straddle National Day weekend)!

Looking forward to hearing from you!

Be well and prosper.

java_guru said...

err pg...sorry to burst your bubble but $50-60 grocery bill can cut it for a small family. Have u seen the cost of diapers and milk powder spiral over the last year? it is now $50 for a 1.8l tin (2 wks supply for 50% milk diet baby) and $25 for about 50-60 diapers (2 weeks supply).

I need more baby bonus QUICK!

8percentpa said...

Hihi very interesting post. Parkinson's Law definitely works. In fact I think it works in all aspects of life, not just time and money. E.g. I doubled my bookshelf capacity and somehow it fills up even though I am quite sure I didn't double the amt of books I bought!

One comment I would make about cars is this: it is still manageable without getting a car even if you have babies.

It's just a bit more planning that's all.

Like call for a cab 15 mins before you want to leave a complex, it's $2.50 more vs $1000 in total cost for a car.

thelonetraveller said...

I'm quite puzzled by people who believe they deserve something good for the "hard work" they put into their jobs. Sounds pretty much like a form of compensation. Could it be because they aren't doing what they are more suited for?

musicwhiz said...

Hi LP,

I do agree that sometimes we define what are "needs" and what are "wants". But I think in other cases it's more clear-cut, like for example a super expensive ice-cream which costs S$20 per scoop (just an example !). You are not wrong to say some "wants" may be "needs" for others, there is always a "gray area".

Working for most people is a NEED cos they need the money, but as you say it becomes a WANT when one is financially free and one enjoys his job so much that he would choose to work for free.

And of course, as we grow older (and hopefully wiser !), our definition of WANTS and NEEDS will also change. A change in family circumstance (e.g. sick parents, newborn child) can have the same effect.

Regards,
Musicwhiz

musicwhiz said...

Hi Anonymous (July 28),

It's amazing that you can save 50% of your income (I assume you mean take-home pay), since most people typically save only 10-20% (myself included). However, I am trying to increase this to 30-40% gradually.

On the points you mentioned:

1) Haha I think what you mean is to work for satisfaction and to feel "useful". Yes that is definitely a case when one "needs" to work. :)

2) Yep I had neglected to delve too much into this but I do agree one cannot be frugal to the point of being miserable (depriving oneself of the basic joys of life). I also give myself some leeway to enjoy a good meal or a nice movie (with overpriced popcorn) once in a while.

3) While I may not have kids yet, I can relate to your statement. We must not give the impression to the younger generation that we are "cheapskates", otherwise they will grow up to be stingy pokers too !

Cheers,
Musicwhiz

musicwhiz said...

Hi Anonymous (July 29),

A good point you raised ! Having a child definitely changes the equation and will cause you to not be able to save as much as before. It's understandable and acceptable that some WANTS become NEEDS, and we have to find balance in the way we spend to overcome it.

I feel that as long as your life is frugal and you do not have a habit of living beyond your means, having a kid should not put too much of an additional financial burden on you (I might be wrong cos I don't have a kid yet hehe).

Another method I can suggest to your good self is to earn passive income from investments (e.g. dividends, rental) so as to keep up the income stream in addition to your job. This can be done through investing.

Regards,
Musicwhiz

musicwhiz said...

Hi Panzer,

Thanks for sharing your experiences. Hopefully my finances won't be too strained should I decide to have a child. Everyone's telling me how expensive it is and scaring the hell out of me but I still desire to have a kid (because as you say, the joy cannot be measured in monetary terms). I guess on my part, that will be my sacrifice in terms of building my wealth; so that I can "stop to smell the roses".

Cheers,
Musicwhiz

musicwhiz said...

Yo Panzer,

Thanks for informing on the blog carnival (it's a new concept to me). I will mull over your question and will drop you an email when ready.

Regards,
Musicwhiz

musicwhiz said...

Hi java_guru,

Wow so baby stuff really costs so much eh ? I will make a note of that in case I decide to have a kid ! Anyhow, the Government will come up with more incentives in August 2008 to help couples cope with rising costs; so hope that will be a boon to you.

Regards,
Musicwhiz

musicwhiz said...

Hi 8percentpa,

What you say is true - I have seen couples manage with baby on a bus (yes, complete with pram and milk bottle too) as well as the MRT. It is difficult but not impossible to manage but of course it helps if our local Singaporeans are more considerate sometimes. As for cabs, I had heard that the cost of calling for a cab and taking one is about the same as zipping around in a car, as a result of the recent fare increases. Families may not see much savings taking cab as compared to car; so I would still think bus and MRT are the ways to save money.

Some may argue that the hassle is not worth it. To each his own. :)

Regards,
Musicwhiz

P.S. - Your bookcase analogy is indeed very apt with regards to Parkinson's Law !

musicwhiz said...

Hi thelonetraveller,

Yes, perhaps. People who really love their job would, presumably, do it for free. However, I have yet to come across such people !

Cheers,
Musicwhiz

thelonetraveller said...

Hi Musicwhiz,

Haha. I stopped short of saying that (because we live in the real world, don't we? =P).

What I meant was people who are doing what they like or are suited for, seldom fall into this "I-deserve-better-since-I-work-so-hard" mode of thinking.

Of course, it could be that they happen to be financially prudent as well.

Cheers!

musicwhiz said...

Hi thelonetraveller,

Yes, we live in a very real and cruel world (it's so dog-eat-dog !). Usually people who work hard expect due rewards (I am no exception to this).

But being financially prudent is an important part of the equation too; if not, then no amount of work and salary can satisfy your wants. :)

Regards,
Musicwhiz