We all know there are two sides to balance sheets. We do not, however, act upon this knowledge as we should. Investors wanting a comfortable retirement must think about how we manage our liabilities – our future outgoings – as well as our assets.
The point here is not simply that we must be cannier shoppers. It’s that much of our spending is in fact investment. And just as we need discipline, strategy and good habits when we buy shares, so we need them when we buy goods and services.
It’s trivially obvious that some of our spending is in fact investment. A washing machine, for example, delivers a flow of future laundry services and saves us the time and money of trips to the launderette. It is a capital good.
So is much else of what we buy. Spending on books and music are investments in what the Nobel laureates Gary Becker and George Stigler called “consumption capital”. Not only do we get benefits from them years later but also they build up our skills of literary and music appreciation which better enable us to understand books and music we buy in the future.
A happy retirement requires that our wealth be sufficient to fund a good lifestyle. We cannot rely upon investing in equities alone to achieve this, not least because of the danger that their returns will be poor. We also need to have a low-cost satisfying lifestyle. And this requires leisure skills – ways of enjoying our free time. Such skills require investments of time and (a little) money in activities such as reading, physical exercise, playing musical instruments or learning foreign languages. These investments reduce our future liabilities by enabling us to do good things without spending much money. That’s as good as increasing the value of our assets.
There is, though, another form of investment. Itzhak Gilboa at the University of Tel Aviv points out that spending on experiences such as holidays or even nights out are investments in memories: they give us a stock of things to look back on happily in later life. And a stock that yields useful services is a capital good.
Much of our consumer spending is therefore in fact an investment.
And here’s the thing. Just as our investments in equities sometimes go wrong, so too do our investments in goods and services, and for analogous reasons.
Just as we sometimes invest in plain bad stocks, so we sometimes invest in forms of consumption capital that have negative future payoffs. Spending on drugs and cigarettes can give you an addiction that raises your future outgoings – that is, add to your liabilities. In the same way, spending on fine wines and fancy restaurants leave you with expensive habits.
We can also over-invest 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 squandered.” He invested in a stock of memories – but he might have overdone it. Similarly, while buying one or two guitars is a sensible investment in a leisure skill, buying one or two dozen is less so. (At least according to the wife of a friend.)
Just as we can over-invest, though, we can also under-invest. Investing in leisure skills such as keeping fit or learning a language requires effort – which we sometimes don’t want to put in. After a long day at work, we’d rather flop in front of the TV – failing to foresee that we’ll feel guilty about our indolence later.
Which is not our only error of foresight. Christopher Hsee at the University of Chicago points out that we don’t anticipate that we’ll become accustomed to fancy cars and big TVs and so won’t get as much satisfaction from them as we would from socialising or developing our leisure skills. And so we spend too much on one and too little on the others.
Maynard Keynes famously said that the object of investing was to overcome “the dark forces of time and ignorance”. He omitted to add that such forces operate not just upon our equity investments but also upon our spending plans, because we cannot accurately foresee our future preferences.
There’s another parallel between our equity investments and our spending: both are shaped by peer pressure. Ben Jacobsen at Tilburg University has shown that our family and friends influence our asset allocation decisions more than they should. The same is true of our spending. Dutch economists have shown that when somebody wins a new car in the country’s postcode lottery their neighbours who didn’t win are more likely themselves to buy new cars. Our choices of investments and spending are partly socially constructed. A sensible consumption strategy requires that we choose (or fall into) the right pond, to use Robert Frank’s phrase – friends and neighbours with frugal tastes. A cheap date is a great thing.
One big fact tells us that bad spending decisions are common. It’s Richard Easterlin’s finding that “the long-term growth rates of happiness and income are not significantly related”. Our spending power has increased in the last few decades, but we’ve been largely unable to convert that power into satisfaction.
What we need, then, is something like what private equity did from the 1990s onwards. Its success consisted to a large extent not so much in managing companies’ assets better, but in managing their liabilities – in switching from equity to debt and refinancing debt to reduce expenses. Many of us perhaps shouldn’t increase debt, but we should heed the general principle – that our liabilities need managing as much as our assets. Good equity investing requires us to form good habits and avoid well-known errors. The same is true of our spending.