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“An attempt to save money which actually leads to greater expense.”Collins English Dictionary.
Have you ever purchased a cheaper option, only to have to replace it and realise you should have paid more upfront for a better quality product?
These types of examples are probably what most of just think when “false economy” is mentioned. But there are many more ways in which false economies can trip you up in your financial life.
When living paycheck to paycheck, consumers inefficiently waste money as they can’t afford to pay upfront for long term value.
But even those on good incomes easily fall into the trap and pay more over the long term by trying to save money. Most of us think too short term to capture the maximum utility from our lifetime income.
This article aims to help you start thinking more long-term, spending your money in the most efficient way over your life so you can use it to squeeze out more fun overall.
1. False Economy in Purchase of Goods
We have probably all made these kinds of mistakes. When cash is tight, it’s tempting to buy the cheaper option in the hope of holding on to your cash. Of course, cost doesn’t always equate to value.
The $12 target t-shirt is likely thinner, has poorer quality material and stitching than the Gap or Christian Dior shirt.
Many may find the Gap (or similar) option provides better value for money, as they can wear the shirt for years without it wearing out.
If you are buying a shirt for a child, or are likely to stain your t-shirt with sunscreen or just being clumsy, the cheap Target option may be the ideal option (environmental, ethical and personal style would also weigh into the debate of course).
It seems unlikely the Christian Dior shirt offers 20 x the longevity of the middle range shirt. Perhaps if you were trying to attract a superficial but wealthy life partner? Although that doesn’t sound like a story with a happy ending!
I know I have been tempted into false economies when reluctant to spend my hard-earned cash on something as boring as a household appliance. Buying the cheapest washing machine may lessen the pain at the time. But if it needs to be replaced in 3 years, uses up excessive power and water, or cannot be easily repaired you may regret it.
When buying goods, spend some time considering:
- How you will use them (how often, how well looked after)
- How long do you plan to use them
- Reviews from family, friends, and online of your purchase options
- Cost differential vs value
2. Paying for Services vs DIY
It is tempting to try and DIY everything to try and save money. A lot of the time, this can be effective. You may learn new skills and even have fun.
But sometimes you end up saving less money than you would have earned working that number of hours. Worse, if you end up with a disastrous result it could cost you a lot more to fix it up.
Consider carefully which services you need a professional to get the job done properly. Weigh up how much time it would take you to perform the job yourself vs working some extra hours to pay a professional.
Be honest with yourself though! I suspect it’s not uncommon for high-income earners to work an extra 2 hours will cover a weekly cleaner plus change. But they don’t do the extra paid work, or anything else productive so the cost just eats into their potential savings.
When considering whether to DIY or pay a professional:
- What will the result with DIY vs profession
- Cost of professional service vs Cost of your time
- Will you use the extra time to earn the extra?
- Can you afford the extra money to be spent out of your income
3. False Economy in Paying/Saving Interest
Paying the minimum payment on a credit card balance makes the repayment seem “affordable”. Credit card companies (much like investors) love to receive compounding interest every month.
Many credit cards have a 2% minimum payment, and a 15%+ interest rate. Paying the minimum repayment will create great wealth for the credit card company, but spiral the consumer into increasingly oppressive debt it’s hard to escape from.
Avoiding all debt to avoid paying interest can also be a false economy though.
Credit cards and other high-interest debt are almost never productive. Investment debt is considered good, or productive debt.
Investing borrowed money to earn returns greater than the interest paid is a common (but optional) way to accelerate wealth building.
Homeowner debt is considered tolerable, but when maintained instead of paid down to allow investment of funds instead, is as productive as investment debt (though you may want to consider debt recycling to improve tax efficiency).
Paying down your home mortgage can be considered a false economy due to the potential investment returns lost.
But this has to be weighed up against the significant emotional gains of having a debt-free home. With recent 70%+ increases in income protection insurance, paying off your home loan may provide better value by allowing you to reduce insurance requirements.
4. Deferring Critical Spending
When considering a potential expense, consider whether it is essential. Often the inevitable spending are the boring costs none of us wish to pay for.
Home maintenance is a classic example. Regular maintenance is likely to prevent larger and more costly repairs in the future.
Looking after your health is another. Preventative health checks can avoid a whole world of pain, emotionally and financially. Not being able to work in a few years time is likely far more costly than just dealing with a health issue when it is reasonably small and manageable.
5. False Economy with Your Time
Anyone who has been following the personal finance crowd for a while will understand that personal finance is not really about money at all.
“Finance enthusiasts” get their money sorted in order to gain control over their life, particularly their time.
Terrible things happen to great people all the time. And it’s far too easy to assume we have all the time in the world.
Avoiding productive and meaningful activities because you don’t “have time” and waste too much of it scrolling or watching Netflix is a false economy. Make the time first for the most important things to you. Try and fit the rest around this. What are your big rocks to get in the jar first?
6. Skipping the Emergency Fund
Some sites (particularly for doctors) advocate skipping the emergency fund.
I think each individual has different emergency requirements. But most of us could imagine a one to two thousand dollar expense that could come up. Those with families, homes, and investment properties could have unexpected expenses running into the tens of thousands easily.
You may need a backup fund in case of unemployment. Do you have a permanent contract and are an essential worker? Are you a single or double-income household?
If you save equivalent to the largest emergency expense you can imagine each month, perhaps you can use a credit card (kept only for emergencies) to cover the expense until payday? I am pretty risk-averse, but we are all different. I can see for those without a mortgage, earning ~1% interest for emergency fund savings is unappealing.
Make sure you think about all scenarios in detail before deciding to give up on the emergency fund. I wouldn’t be without it.
If you have a mortgage offset account, you can keep an emergency fund in there and save interest (tax-free). There is still an opportunity cost of keeping your cash in an offset over investing, but it is not as severe.
Those with a mortgage offset will at least be able to save interest equivalent to long-term inflation.
7. Saving Money on Critical Insurance
I know, another horribly boring way to spend money! People are tempted by the two extremes – either paying for every insurance going due to loss aversion or tempted to skip critical insurance.
When considering insurance, I am a big follower of Scott Pape’s advice to only insure for catastrophic events. If you can afford to self insure, do so.
If you drop your phone, it is really annoying having to pay to replace it. But it won’t cause a major problem in your financial future. If your house burns down, or you crash into someone’s Mercedes, these unexpected expenses could make a big impact on your financial life.
Getting insurance right unfortunately requires us to think about potential events no one wants to acknowledge as a possibility.
What if you or your partner are killed, permanently disabled and unable to work? Or a child gets a significant, potentially life-threatening condition?
Hopefully, this time will be wasted as these events will never happen. But if they do, the fact you prepared “just in case” will provide some relief and a lot less stress on top of what is already an extremely stressful and unpleasant experience.
8. Not Investing in your Relationships
Perhaps you have drunk the personal finance cool-aid, and are completely on board with delaying gratification for the greater financial good.
There still needs to be some balance along the journey.
If you sacrifice everything, work every hour available, hit a super high savings rate but have no time to spend with the ones you love, you are very likely to regret it.
Relationships are what make life enjoyable, far more so than incredible luxuries and experiences. Have you ever been sightseeing on your own? It just isn’t the same without someone to share it with.
Neglecting your family and friends can lead to more distant relationships that can be hard to heal. Not treating your spouse as you should can lead to the potentially most expensive life event of all, divorce. Neglecting your kids will lead to a lifetime of regret that no amount of money will compensate for.
Cherish those important to you. Make it a priority, and build habits that strengthen the bonds that are important to you. For those that tend to forget, and time slips by, create regular reminders (I use todoist*) for yourself to check in with the important people in your life.
9. Neglecting Saving for Retirement
Retirement is not a very appealing prospect in your 20s and 30s, particularly if you are embarking on an exciting career.
But saving for the long term will provide so many benefits and options available only to those who are financially secure with savings.
You are also probably broke and think you can’t afford it. But it really only takes a tiny amount when you are young to make a big difference over the long term. In your 20s pick the low-hanging fruit. Take advantage of low-income and spouse contribution tax offsets when you can. Consider starting a micro-investment account and start investing tiny amounts whilst learning about the stock market. Salary sacrifice to gain any employer bonus super contributions. If you know where you’re going in life, make a plan. If this is overwhelming, start saving and build up to a savings rate of 20%.
When you can afford a little more, try to increase your salary sacrifice or deductible super contributions to reduce your tax burden. Build up to maximizing your concessional contributions as your income improves. When that pay increase comes, think about making or adjusting your plan, and investing outside superannuation if appropriate.
Waiting until your 50s to start ramping up super contributions is inefficient, particularly if you then need to make non-concessional contributions (having paid your full tax). Spreading super contributions throughout your life is the most efficient use of your money due to tax concessions and compound interest. That leaves you with more money over your lifetime for the fun stuff!
10. Blowing your Pay on Tax
Tax is our biggest (by far) expense, costing around 30% of gross income. Over a 20 year career as a staff specialist, I expect to pay at least $2.6 million in tax.
You will pay a lot of tax over your lifetime, depending on your career and working longevity, more or less than the figure above.
Doctors often make foolish decisions, led by the desire to pay less tax. Making investments for tax savings is a terrible idea. Spending money for the tax deduction also doesn’t make any sense. At least 55% of the cost is coming out of your own pocket rather than the ATOs.
So decisions should generally not be made based on potential tax savings, but once a decision to invest or spend on a tax-deductible expense, an effort should be made to ensure tax is minimized. This means, making sure you have a system for collecting details of tax-deductible expenses so you don’t forget any at tax time. With investments, consider the tax implications before committing, as a change in the structure in which you invest may make a significant difference (trust, super, company, individual, education investment bonds).
The one investment I think you should consider tax first is superannuation. If you are paying 32% tax, you will receive a 17% immediate return by salary sacrificing extra into superannuation.
By taking advantage of spousal super contributions while they have a low income you will receive up to 18% immediate return.
The government’s co-contribution scheme will provide a 100% immediate return on $1000 voluntarily contributed to superannuation earning less than $41,112. That is a risk-free return. Unbeatable!
All these benefits have income thresholds, and super balance limits set, which means you will become ineligible as your income and super balance increase. Take advantage of huge risk-free returns while you can!
False Economy Conclusion
Avoiding false economy spending is all about thinking long-term. Few of us can see our entire life’s trajectory, so often we are forced to work on likelihood.
Spend some time weighing up how to deploy your funds effectively over your lifetime, and get the most bang for your buck.
Aussie Doc Freedom is not a financial adviser and does not offer any advice. Information on this website is purely a description of my experiences and learning. Please check with your independent financial adviser or accountant before making any changes.