Consumption Strategies – Investor Column


We all know that balance sheets have two sides. However, we do not act on this knowledge as we should. Investors who want a comfortable retirement need to think about how we manage our liabilities – our future expenses – as well as our assets.

The point here is not simply that we need to be savvy shoppers. It is that a large part of our expenditure is in fact an investment. And just as we need discipline, strategy, and good habits when buying stocks, we need them when buying goods and services.

It is quite obvious that some of our expenditures are in fact investments. A washing machine, for example, provides a flow of future laundry services and saves us time and money on trips to the laundromat. It is a capital good.

The same goes for much of what we buy. Spending on books and music are investments in what Nobel laureates Gary Becker and George Stigler have called “consumer capital.” Not only do we benefit from them years later, but they also strengthen our literary and musical appreciation skills, giving us a better understanding of the books and music we will buy in the future.

A happy retirement requires that our assets be sufficient to finance a healthy lifestyle. We cannot rely solely on equity investments to achieve this, especially given the risk that their returns will be poor. We also need to have a fulfilling, low-cost lifestyle. And this requires leisure skills – ways to enjoy our free time. Such skills require investments of time and (some) money in activities such as reading, physical exercise, playing musical instruments or learning foreign languages. These investments reduce our future liabilities by allowing us to do good things without spending a lot of money. This amounts to increasing the value of our assets.

There is, however, another form of investment. Itzhak Gilboa of Tel Aviv University points out that spending on experiences such as vacations or even nights out are investments in memories: they give us a stockpile of things to look back on happily later in life. life. And a stock that produces useful services is a capital good.

A large part of our consumption expenditure is therefore in fact an investment.

And here’s the thing. Just as our investments in stocks sometimes go wrong, so do our investments in goods and services, and for similar reasons.

Just as we sometimes invest in just bad stocks, we sometimes invest in forms of consumer capital that have negative future returns. Spending on drugs and cigarettes can give you an addiction that increases your future spending, that is, adds to your debts. In the same way, spending on fine wines and fancy restaurants leaves you with expensive habits.

We can also overinvest even in good things. The late George Best once said, “I spent a lot of money on booze, birds and fast cars. The rest I just wasted. He invested in a stock of memorabilia – but he may have overdone it. Likewise, while buying a guitar or two is a wise investment in a hobby skill, buying a dozen or two is less so. (At least according to a friend’s wife.)

However, just as we can overinvest, we can also underinvest. Investing in hobbies like keeping fit or learning a language requires effort – which sometimes you don’t want to put in. After a long day of work, we prefer to slump in front of the TV – failing to foresee that we will feel guilty for our indolence later.

Which is not our only error of foresight. Christopher Hsee of the University of Chicago points out that we don’t expect to get used to fancy cars and big TVs and therefore won’t derive as much satisfaction from them as we would from socializing or developing our skills in Hobbies. So we spend too much on one and too little on the other.

Maynard Keynes said the object of the investment was to defeat “the dark forces of time and ignorance”. He failed to add that these forces affect not only our equity investments, but also our spending plans, as we cannot accurately predict our future preferences.

There is another parallel between our equity investments and our spending: Both are shaped by peer pressure. Ben Jacobsen from Tilburg University showed that our family and friends influence our asset allocation decisions more than they should. The same goes for our expenses. Dutch economists have shown that when someone wins a new car in the country’s postcode lottery, their neighbors who didn’t win are more likely to buy new cars themselves. Our investment and spending choices are partly socially constructed. A sensible consumption strategy requires that we choose (or fall into) the right pool, to use Robert Frank’s phrase – friends and neighbors with frugal tastes. A cheap date is a good thing.

An important fact tells us that poor spending decisions are common. This is Richard Easterlin’s conclusion that “the long-term growth rates of happiness and income are not significantly related”. Our buying power has increased over the past few decades, but we have been largely unable to convert that power into satisfaction.

What we need, then, is something like what private equity has been doing since the 1990s. Much of its success has been not so much in managing corporate assets better, but in managing their liabilities – moving from equity to debt and refinancing debt to reduce expenses. Many of us may not want to increase our debt, but we should heed the general principle that our liabilities should be managed as much as our assets. Good stock investing requires building good habits and avoiding well-known mistakes. The same goes for our expenses.


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