In the book ‘Richest man in Babylon‘, the author lays out what he calls “seven cures for a lean purse” for wealth building, each fairly simple, but if followed diligently over a lifetime, will build wealth. If you’re too busy to read the book, take a look at this post summarising the key points and how they apply to the young Indian investor.
Revisiting one of the seven cures, namely, the 2nd cure that says to “control thy expenditure” because “what we call ‘necessary expenses’, will always grow to equal our incomes, unless we protest to the contrary.”
Think back to your first paycheck. Depending on how long ago that was, it might be a ridiculously small amount compared to what you make now. In addition to nostalgia, you might experience two realizations:
- how pitifully little you can do today with that amount thanks to inflation
- a sense of marvel at how you managed to live a functional life on that income
In my case, a large part of it went as rent in the apartment I shared with two friends. A chunk for petrol for my pride and joy, a Kawasaki Bajaj Caliber motorcycle. Utility bills, domestic help, laundry, groceries. Add the odd dinner out, movies over the weekend and I was close to hitting the minimum balance in my savings account by the end of the month, just before the next credit came in and I started again.
Over time though, that income went up, usually through year-end raises, ardently celebrated at the favourite hangout. I “adjusted” to the added income in many little ways. By increasing the frequency of shopping for clothes, buying the box set of of my favourite music albums and so on. Like it says in the 2nd cure, the “necessary expenses” crept up to match my (modestly) growing income.
And what of it? you might ask. Isn’t the very point of working hard, to be able to improve your standard of living, to enjoy the finer things? If you had intervened 14 years ago at the audio store as I was about to buy ‘The Vault‘ a compilation of Def Leppard’s hits, with the argument that I wouldn’t have that money to spend when I was old, I’d have looked at you very strangely.
So, do we then accept that our “wants” will increase in direct proportion to our income and that’s ok? Alternatively, the only way to build wealth for the long-term is to deny ourselves in the present?
Not quite. Enter, a fundamental law of economics.
Law of diminishing marginal utility
You’re coming to the end of a long day. You were so busy that you didn’t get a proper lunch. You’re famished and as you’re about to reach home, you decide to order a whole large pizza, with your favourite toppings. You feel you deserve it after the day you’ve had.
You can barely contain your excitement as the pizza arrives, the box, invitingly warm. You settle in on the couch, tune into yet another rerun of ‘Predator‘ on TV and grab a slice.
It’s delicious! The hunger pangs make you wolf it down in a matter of seconds. Feeling better, you reach for your 2nd slice, also devouring it, only slightly slower. You take your time with the 3rd slice, closing your eyes and revel in what must be perfect pizza goodness. You no longer feel the intense hunger you were feeling a few minutes ago. You take a breather to watch Arnold match his muscles against an alien, before reaching for your 4th slice. You take your time with this one, as you start to feel satisfied and even slightly full.
By the time you finish your 5th slice you can barely get up and vow to not order pizza for a long time.
Represented graphically, note in the chart above, how the utility, the value / enjoyment / satisfaction you get from consuming increasing quantities, in this case slices of pizza, rises sharply as you consume your first couple of slices and then flattens out with subsequent consumption. Such that, the additional utility you got from consuming the 4th slice was much lower and the 5th slice of pizza added almost nothing to your well-being. You’ve just experienced “the law of diminishing marginal utility”, developed by Carl Menger, founder of the Austrian school of economics.
Pay attention and you’ll notice this pattern applies to most things we consume or use in our lives. The joy of buying your 1st pair of branded Levi’s jeans is seldom matched by the 4th or 5th pair. You probably enjoyed your Maruti Alto more than the Honda City you upgraded to. The 2nd Tag Heuer watch you buy may or may not be as exciting as your first Titan timepiece. Hopefully, you are yet to experience the feeling of buying your first Titan, and if so, you might want to check out a site like WatchShopping because that feeling is something that you will not forget for a long time.
Demand more from your purchases
How can we use this intuitive law governing consumption of most kinds, to work for us? By setting a minimum expectation of utility or satisfaction before deciding on spending money on a purchase.
Will this pair of jeans / car / luxury timepiece / etc. give me the satisfaction that either avoiding it or a much baser version of the same could not give?
If that answer is “not really” or “I don’t really know”, you’re better served keeping your credit card back in your wallet. Applying that critical thinking to how you spend your money will help prune the unnecessary purchases that would do nothing for your quality of life.
Note the emphasis on “your” quality of life. The idea here is not to avoid every indulgent purchase, because that would be a dull life indeed. The flashy Tumi laptop bag might offer a lot more value to someone who appreciates fine accessories while being just a bag to you. On the other hand, you might better appreciate the details on a Breitling SuperOcean wrist watch and therefore get a lot of utility from purchasing it.
The takeaway is to be more aware of when and why you spend your money and to have a clear idea of the value you get from your purchases. Not to deny yourself every pleasure today for the sake of a prosperous old age, but to get true value for your money. This means pausing after the 3rd slice of pizza to self-check whether you picked up the 4th simply because it’s there or if you’re hungry. If not, to put it back so you can enjoy that ice-cream later without feeling guilty about overeating (spending).
That’s one way to “Control thy expenditure” and therefore have more left to invest, compound and build wealth.
What can the law of diminishing marginal utility teach us – Mises Institute