It is indeed a material world. Our culture of consumption is marked not only by rising levels of disposable income, but by rising consumer debt and declining household savings. Economists may tout the virtues of consumer spending in keeping economies afloat, but on a personal level increased debt is cause for concern.
The Federal Reserve Bank of Cleveland reports that the personal savings rate in the U.S. declined roughly 10% from 1985 to 2005, while the debt-to-income ratio nearly doubled. Canada has followed a similar course, with household debt rising at twice the rate of disposable income over the same period.
Though statistics such as these may lead us to think that overspending is normal, it is not necessarily wise and can prove disastrous. Be aware of these common financial mistakes and how to avoid them:
Frivolous Spending
Fortunes can be lost one dollar at time. It may not seem like a big deal when you pick up that double iced mochaccino, go to that feature film or order that CD online, but every little item adds up. Just $25 per week spent on dining out costs you $1300 per year, which could have gone toward your mortgage or car payments.
Never-Ending Payments
Do you really need items that keep you paying month after month, year after year? Cable television, subscription radio, cell phones and pagers require ongoing payments but leave you owning nothing.
Credit Cards
Living on borrowed money has become normal. More and more consumers are willing to pay double-digit interest on gasoline, groceries and a host of other items that are gone long before the bill is paid off. Paying interest for failure to pay off credit card bills greatly increases the price of charged items.
New Cars
Millions of new cars are sold each year, though few buyers can afford to pay cash for them. The inability to pay cash for a new car means an inability to afford the car, even if you can afford the payments. Borrowing money on a car means paying interest on a depreciating asset. This amplifies the difference between the value of the car and the price paid for it.
Many people trade in their cars every few years, even though factory warranties often provide 100 000 miles or 10 years of coverage.
More Car Than You Need
Some of us have no choice but to own a car, but how many of us really need an SUV? These vehicles are expensive to buy, to insure and to keep fuelled. Unless you tow a boat or trailer, or need an SUV to earn a living, is an oversized engine worth the extra cost? If you need to buy a car, consider buying one that uses less gas and costs less to insure and maintain.
Too Much House
Smaller can also be smarter when you are in the market for a home. Unless you have a large family, a 6 000 sq ft home is probably more than you need. Taxes, maintenance and utilities on such a big house will put a significant dent in your monthly budget for years to come.
Refinancing Your Mortgage and Taking Cash Out
Your home is your castle. Refinancing it gives ownership of it to someone else. It also costs you thousands of dollars in interest and fees. You should be building equity, not paying in perpetuity.
Living Paycheque to Paycheque
The cumulative result of overspending puts you in a precarious position, one in which you need every dime you earn. One missed paycheque could be disastrous. It is not always a matter of earning more money; it is a matter of spending less than you earn. Everyone has a choice to make savings a priority.
The U.S. household savings rate is at levels not seen since the Great Depression. In 2007 it was not even at 1%. Compare this to most European countries, which have personal savings rates of 10% or better. Countries in Asia boast savings rates of at least 30%.
Making Payments vs. Affording a Purchase
To avoid the dangers of overspending, compare credit card debt with consumer loan and start by monitoring the little expenses that add up quickly. Then keep an eye on larger expenses. Think carefully before adding new debts to your list of payments, and keep in mind that being able to make a payment isn’t the same as being able to afford the purchase. Finally, make saving some of what you earn a monthly priority.