The Limits of Small Economies

by Philip Brewer on 23 January 2013 1 comment
Photo: alvarolg

The first step always recommended to people whose finances are out of control is that they institute some small economies. Quit with the fancy coffee drinks. Brown bag it for lunch. Switch to generic brands at the grocery store.

These steps are mentioned first not because they're the most important, but because they're quick, easy, and (almost) universally appropriate. But the hard truth is that small indulgences are not what ruin people's finances. (See also: Simple Living Through Capital)

Financial Ruination

People's finances are ruined two ways:

  1. A sudden drop in income.
  2. A large uninsured expense.

I started to make separate lists of the sort of things that lead to these problems, but it turns out there's so much overlap that one list pretty much covers it: Unemployment, illness, accident, divorce, lawsuit, natural disaster, business failure, disability, etc.

Those are the things that cause individual financial collapse, not being unable to resist the latest shiny high-tech gadget.

Failure to Thrive

Which is not to say that people shouldn't attack the small indulgences. That's still worthwhile, for two reasons.

First, they're something that you can take action on right now.

Attacking the big things often takes months or years of effort before there's any payoff — moving to a cheaper house, getting a better job, changing careers, settling a lawsuit. (And that's putting aside the really terrible situations like a terminal illness where there's literally nothing you can do to fix things.)

Saving a few bucks every week won't fill the hole blown into your finances by a major disaster, but it does give you something positive to do.

Second, although small indulgences are rarely if ever the reason for ruination, they do make it hard to get ahead.

Back before interest rates were so low, it would have been possible to write a little parable here about how much money you could save over 10 years if you cut your expenses by $20 or $50 a week.

At current rates, that story isn't so compelling now. But however little money small sums invested at low rates for a few years adds up to, it still leaves you way ahead of the alternative — small sums borrowed at high rates for a few years. (Go ahead and crank the numbers on that if you don't believe me.)

However you figure it, small economies do give you the chance to accumulate a little capital, and a little capital improves your life in many ways.

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M

Phil, you are so right. I suspect you'll get skewered by both sides of the camp, however. At least for me, saving small sums gives me the correct mindset for exploring more self-reliance. That, in turn, gets me thinking about the bigger stuff and whether I really even need it. It becomes psychologically freeing and that's the real payout for me. cheers.