Wednesday, August 29, 2007


"Obstacles cannot crush me.
Every obstacle yields to stern resolve."

- Leonardo da Vinci

There has been a confluence of events in my life this summer, some large and some small. Together, they have created a quiet resolve to make early retirement really happen.

Assuming that a goal is realistically obtainable, the biggest determinant of success is usually motivation. For a lengthy project, a high level of resolve is at the same time both very easy and very hard. For example, you may decide you are going to exercise 30 minutes today, and assuming you don't have a medical condition preventing you from doing so, this should be quite easy to accomplish. However, suppose you decide you are going to exercise 30 minutes every day for the next year. Everyone knows that is not easy! Each new day presents you with the same small step that is easy to accomplish, but taken together as a whole year, the steps become hard.

Can I stick to a budget again for 5 more years? Can I endure my current employment for 5 more years? Can I resist tapping into my savings and blowing it on something for 5 more years? Can I remain absolutely disciplined in investing my savings for 5 more years?

Each day I can easily do those things, but as a whole, they sometimes look very hard. That tells me that in the end, if I fail, it will likely be that I simply didn't want it bad enough, and that is a sobering thought. Will I look back and see that I didn't want early retirement as much as I wanted a new car, a remodeled bathroom, or the thrill of a penny stock?

A few days ago, CNN/Money published an interview with a Nobel Prize winning psychologist who researches how and why people make investment decisions. When asked about money and happiness, he responded: "Happiness is determined by factors like your health, your family relationships and friendships, and above all by feeling that you are in control of how you spend your time." [emphasis added]

That is a very good description of what I am pursuing with my early retirement goals.

Monday, August 13, 2007

Controlling Impulse Purchases

"What you don't have, you don't need it now
You don't need it now, you don't need it now"

- U2, Beautiful Day

I'm amazed at how much some people spend on impulse purchases. I'm not just referring to M&M's and gum at the checkout counter, but also to a lot of large purchases that are made on impulse. As I see it, there are three related (and progressively sophisticated) sales arguments related to the impulse decision.

Argument #1: You need it right now.
This is the initial argument for buying something now and the root of the impulse decision. Our entire society is structured to facilitate impulse shopping: store layouts, credit cards, "one-click" shopping, periodic sales, etc. So if you want to save money in life, you better have a strategy for dealing with the marketing machine. The most successful approach for most people seems to be to have a policy that you will wait a certain period of time. I like this approach because it's a generalized approach that doesn't involve gimmicks like pretending salespeople are "evil" or leaving your credit cards at home when you visit the mall. If you've thought about the purchase for a while, then by definition, it is not an impulse purchase. (Whether it's a wise decision is another matter, but at least it's not an impulse purchase.)

Argument #2: You won't have this opportunity again.
This is usually the counterargument to the use of a waiting period. The salesperson tells you that if you wait until tomorrow, the store might be sold out. The flier in the mail says the sale is only good until the end of the week. A lot has been written about these tactics and how well they work, but suffice it to say that 99% of the time, you'll have plenty more opportunities, and sometimes at even better prices. Here's a true story to illustrate:

We once bought a high-end mattress set that had a display price of about $1400. As you probably know, the price of a mattress is highly negotiable in most stores. It was near the end of the month and the sales lady was quite hysterical in her attempt to get the mattress out the door by the end of the evening. At first it was a simply "on sale today" for $1200. Then she found a "special sale" of $1050. Then she rummaged around in the back of the store and announced that this mattress was overstocked and she could let it go for $900. Later, we heard how "this model was probably going to be discontinued", how "my manager can cut you a special deal tonight", and how "I really need to make my quota for the month" - probably the only honest comment of the night! Eventually she came down to $650. She was almost in despair when I firmly told her that we always had a 24 to 48 hour waiting period to think about large purchases. She offered $615 if we would buy it right now. I felt really bad, but I asked if this price would be good for a couple of days. After she said yes, we thanked her and walked out the door.

Two days later, we decided we definitely did want the mattress and based on our comparisons at other stores, we found that $615 was actually a good price. When we went back to the store, we encountered a different salesperson. We politely told him the name of the other salesperson (to be fair, the commission was hers) and told him the price we were quoted. He looked at us like we were from another planet. "No, no, no, that cannot be right" was all he kept saying. But do you know what? Yes, five minutes later he absolutely did sell us the mattress at that price!

The point of this story is not how much you can haggle for a mattress. Undoubtedly, many people can do a much better job at that. My point is that no matter what you are told by salespeople and by sales literature, today is probably NOT the last day you will ever get that price point. Even in the most extreme of circumstances, it is probably not the last opportunity.

Argument #3: An upgrade is not an additional purchase.
This is the most subtle of the arguments because it's a perfect setup to make a series of mental accounting errors. Behavioral finance theory asserts that people will attempt to frame decisions to segregate gains and integrate losses, and what better way could there be to integrate a loss than by lumping it together with another larger purchase. You know the routine.

You need a new refrigerator and you don't want to be ripped off, so you do your homework. You look at all the models and compare the features and decide which features you really need. Then you read all the product reviews. Finally you shop around and find the best price and you even wait until it is on sale. Now you are certain you've located the best fridge for your needs and at the best price. So far, so good. You confidently walk into the store and announce to the salesperson that you'd like to buy Model A, currently on sale for $499. The salesperson informs you that "Model A is manufactured by a great company, but we don't sell very many of that particular model - it's the older model where the ice maker only dispenses cubes. Model B is the newer model which has all the same stuff, but also dispenses crushed ice. Almost everybody buys Model B; we sell tons of Model B. We've heard lots of great things about Model B. It's also on sale for only $599, which is not much more than Model A, and which is the lowest price it's ever been on sale here."

Five minutes later you've signed the papers for Model B. Now why do we do that? Partly we do it because of the sales appeal to ego (i.e. "newer model", "everybody buys Model B", etc). But we also do it because we don't perceive it to be an impulse decision. We don't think, "Hey, I've just made a well planned refrigerator purchase for $500, and a $100 impulse purchase for an ice crusher." No, we integrate the $100 impulse purchase right into the $500 purchase. $100 looks much smaller that way. In fact, we hardly notice it. In our minds, we are still thinking about what a great job we did researching Model A and getting a great sale, even though we've bought Model B! Notice again how easily we segregate gains, but integrate losses. In fact, most people do not even need a salesperson to nudge them in this direction. Notice how easy it is to say, "Well, I'm already spending $500, so another $100 to get the newer model is not really a big deal." It's interesting that the $100 loss is "not a big deal" when we integrate it with the bigger purchase. However, if Model A was originally $600 but then went on sale for $500, we are very quick to segregate the $100 gain and crow about it. In that case, the same $100 was, in fact, a big deal.

So be alert to the upgrade impulse. You'll notice it everywhere - option packages on cars, warranties on consumer electronics, upgrade packages on new homes. Be especially alert if there is financing involved. For example, suppose you are buying a newly constructed home for $250,000 and the builder is offering 100% financing. If you borrow $250,000 at 6% for 30 years, your mortgage payment will be $1,500 per month. As you are filling out the paperwork, the builder rep suggests that you could upgrade the kitchen countertops to granite. "The difference in monthly payments is almost negligible," he tells you. "The monthly payments will be $1,530 instead of $1,500." Would you upgrade?

Now the point is not whether granite countertops are something one should buy. What you choose to spend your money on is entirely your business. The issue is whether you would still make the same decision if framed differently. In your mind, try to frame the decision so that you aren't comparing the $30/month with the much larger number of $1,500/month, and try to isolate the purchase as much as possible. For example, would you be comfortable constructing a budget where you break out a separate line for granite countertops: $360/year? Would you still make the purchase if you knew the countertop upgrade cost $5,000? ($5,000 amortized over 30 years at 6% is $30/month.) Would you still make the purchase if you knew the upgrade would cost $10,800 after interest expenses? Alternatively, imagine that the builder never offered an upgrade, but you were contacted separately by a reputable home remodeling store. Would you be willing to separately pay them $5,000 to upgrade the countertop during construction?

If you answer "yes" to all those questions, then the upgrade probably makes sense for you. There is certainly nothing inherently wrong with having nice things. However, if you answer "yes" to some questions but "no" to others, then your choice depends on how the decision is framed. The inconsistency in the answers is a powerful warning sign! It's probable that you would like to purchase the item but not think about the costs, or that you are being manipulated, or both.

And finally, you may be asking why the big deal about impulse purchases anyway? The reason it's important is that the success of any large project depends on planning and execution, and financial projects are no exception. Large projects like paying off your debt, saving for your children's college expenses, and saving for your retirement require setting goals and follow-through. In order to have success in reaching financial goals, you must plan well and execute. Repeated impulse purchases destroy your budget and severely weaken your chances of achieving your goals. Nothing is guaranteed in life, but you have to focus on what you can control, and impulse purchases are yours to control if you choose.