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Tuesday, 4 March 2008

Why We Spend and What We Can Do About It

by Sheyna Steiner

A lot of changes have taken place in American society since the 1970s. We have made exponential leaps in technology, for example. Yet people haven't changed all that much. We still respond to societal cues and, as a result, often behave irrationally with money as we face increasing pressures to spend.

According to Stuart Vyse, author of the book, "Going Broke: Why Americans Can't Hold on to their Money," the five variables that controlled spending in the past have undergone tremendous changes in recent history.

These external mechanisms kept people from going hog wild on shopping sprees in the past. As these constraints have loosened, society witnessed a massive increase in personal debt and bankruptcies.

It's gotten easier to spend

Vyse discusses these five variables in "Going Broke":

1. Availability of goods and services.
Before: Warehouse stores, with products packed on shelves from floor to ceiling, weren't as common as mom-and-pop shops. Shopping online was not an option.
Now: Almost anything in the world can be procured just down the road at the superstore or, better yet, delivered to your door with only a few clicks of the mouse.

2. Wherewithal to buy or trade.
Before: Layaway was the common way for consumers to set aside products they couldn't yet afford.

Now: Consumers' buying power is almost unlimited as credit card issuers compete for business.

3. Time to get the goods or services.
Before: Consumers generally planned and saved money before making big-ticket expenditures.
Now: The ability to buy products before you can afford them dramatically reduces wait time. Plus you can get almost anything shipped overnight from all corners of the globe.

4. The effort required to get the goods or services.
Before: You had to at least shower, dress, get in the car and drive to the mall.
Now: Online shopping anyone?

5. Self-service retail society removes social barriers.
Before: Social interaction was virtually assured when shopping. Some purchases involved stigmas or required a level of knowledge or sophistication that the buyer might not have felt comfortable with. Even using a credit card may have been cause for raised eyebrows due to the shame of debt.

Now: There really isn't a stigma to any purchase these days, and using a credit card is much more common than cash. Even if someone were to judge your purchases, you don't have to talk to them until you hand them your credit card -- if at all.

A shift in national priorities

Most people are in debt to some extent. More than three-quarters of all families carry some form of debt, according to the 2004 Survey of Consumer Finances, conducted every three years by the Federal Reserve. That includes credit cards, mortgages, installment loans and others.
Robert Manning, Ph.D., author of "Credit Card Nation," has studied messages about saving and spending that have been imparted from World War I to the present. His findings will be used in the sequel to the film "In Debt We Trust."

In the early 20th century, saving was a national priority, he says. "There was a very strong effort to influence people's savings behavior among the public government sector, the corporate sector and the household sector. So the message of savings was really a national security issue, a core value, and really emblematic of the power and superiority of American society," Manning says.

"Literally any item, from milk to cigarettes and liquor, in that period of America from World War I to the Korean War, was promoting that it was our national duty to save."

Conversely, current messages promote spending as the way to power the economy.

"Now it's the triangle of debt, and what we see is the consistency of the government, corporations and households all basing their budgets on debt," says Manning, director of the Center for Consumer Financial Services and research professor of consumer finance at Rochester Institute of Technology. "Just a generation earlier that would have been anathema."

Vyse, a professor of psychology at Connecticut College, concurs. "We've designed the economy so that the consumer is an important resource for the overall economy," he says. "Unfortunately we are overfishing that resource; we are going to destroy that by putting people in too much debt."

Confusing needs with wants

Basic needs have not changed, yet there are so many more of them now than ever before.
The widespread introduction of indoor plumbing and the associated conveniences of hot showers rendered obsolete the outhouse and chamber pot. Toilets and showers quickly became regarded as necessities. Similarly, recent innovations are considered needs rather than wants.

"We have experienced an incredible technological burst in the past 30 years and things that we never imagined are now things that we can't live without," says Vyse. "And that includes technological devices like computers and cell phones."

The other side of the coin is that keeping wants and needs separate is harder than ever. Though everyone now needs a digital copy of a resume and e-mail, a computer may not be absolutely necessary. Using one at Kinko's or a cyber cafe could be a less expensive alternative.

"The things that you need are at a more basic level," says Steve Bucci, president of Money Management International Financial Education Foundation. "For instance, you need a place to live. You may want a two-bedroom apartment, but you need a one-bedroom or even a studio."
Failure to really differentiate between wants and needs leads to what Manning calls competitive consumption.

Societal pressure to spend

Citizens are exhorted by the government to spend money to get the economy moving. The possessions of neighbors and friends prompt judgment of their relative worth. Even leisure time is dominated by opportunities to spend money.

"The idea of saving and having cash on hand for a rainy day has really gone away," says Vyse.
The population has become obsessed with having the right things and the status that those things ostensibly project. From the cool jeans in high school to the shiny new car or living in the best ZIP code as an adult -- these values can work to the financial detriment of individuals.
Parents can be especially vulnerable to competitive consumption in today's world. Feeling pressure to equip their kids with skills and education to put them ahead of peers in the race of life, parents spend themselves into the ground.

"It seems like parents today have been persuaded that they can't do enough for their children," says Manning, citing expensive summer camps, sports programs and debutante balls as competing demands for their money. "And that then explains why there's not enough savings for college."

Availability of credit

People can borrow buckets more money than ever before. "Over the past decade it's gotten so that a family living on a modest income of $50,000 can leverage up to their yearly income in unsecured credit. That's unprecedented," says Dave Jones, president of the Association of Independent Consumer Credit Counseling Agencies.

"One of the things about the availability of credit is the fact that it allows you to think in the short term. It lets you have this object right now even though you don't have the money in the bank. People can easily get enough credit that they can get themselves in debt," says Vyse.
More recently, the consumer debt debacle was exacerbated by the skyrocketing growth of real estate values plus low interest rates on mortgages, home equity loans and lines of credit which lenders were all too eager to give out.

Alternatives to fixed-rate loans abounded and buyers were allowed to buy more home than they could afford. Homeowners could remodel, take vacations and buy beyond their means on the value of their homes. Then the housing party ended, which led to unfortunate, though not entirely unforeseen, consequences.

"People had borrowed not only up to their income limit but also on the artificial valuation of their homes. And now that those valuations have plummeted, millions of people are in financial shock. They always thought that they could sell their homes and pay off debt, but now they're finding out that their homes have depreciated substantially," says Manning.

Lack of financial education

With the dizzying array of options and responsibilities consumers have, financial education has gotten complicated. In the early 20th century, when there were two options available for making purchases -- save for it or don't buy -- basic financial management was fairly straightforward. Credit was available, though it was very limited or required collateral.

"It was much less easy to go into debt in an era before credit cards became ubiquitous," says Vyse.

Credit has undoubtedly made life easier in many respects. From bigger houses to safer cars, average consumers can extend their buying power. But without education on how to handle the spending power, credit can be as destructive as a high-octane sports car in the hands of a novice driver.

"Debt is a very serious issue and should be understood," says Jones. "We graduate kids from high school every year that don't even know how to fill out a check book register. There is nothing taught in the public schools about personal financial management, and a lot of people don't understand the basics of finances, like credit cards and interest rates and universal default clauses," he says.

Make long-term choices

To a certain extent consumers make choices that land them in the debt hole. When borrowing money, buying on credit or spending instead of saving, choices are being made.
Consumers should try to be more mindful of spending money and account for the total cost of their purchase -- which is often more than the amount shown on the price tag. If you use a credit card and don't pay off the balance each month, interest accrues.

Paying off a large credit card bill over time requires you to commit future earnings to that purchase plus interest. Say you have a $10,000 credit card bill at 18 percent interest and you make minimum payments of 4 percent of the balance. "It will take almost 15 years to pay off that bill, and that's if you never make another purchase on that card," Jones says.

Get rid of your credit card debt

Vyse says people often have the best intentions to pay off credit card debt right away. "But we don't anticipate the normal bumps that come along that will also draw upon our finances. Then it's very easy to get in trouble."

Know what you're up against

Stores target you for impulse purchases; the layout and design of stores and malls is no accident.
At the grocery store, "The milk is always at the back of the store -- it's never by the checkout," says Bucci. "But a lot of people buy milk, so they have to walk through the store.
"The music is chosen carefully to make you feel a little more carefree. That's how they want you to feel. The things that they want you to buy are at eye level. Other stuff is elsewhere. When you get to the checkout line, candy is down low where the kids are."

Advertising also plays into decisions to spend. Omnipresent ads crowd the landscape and have bled into movies and even video games.

People can control their impulses to spend and look toward the long-term in part by limiting their exposure to advertising and making their lives less commercial, says Vyse.

Just tune out those messages that are out to destroy your financial security.

"Also, cultivate leisure time activities that don't involve large sums of money," Vyse says.

Save, save, save

Though plastic makes an easy target, it's only a part of the issue. The real problem is spending and not saving.

The younger generations are being trained to spend rather than save, says Manning. "Many young people have a false impression from their prior generational influences that they've got to get out of debt, and I make the point in my next book that it's OK to be in debt as long as you have a plan to invest. Being at zero dollars at retirement isn't going to do it," he says.

Even if you don't have much credit card debt carried over month to month, spending everything you make rather than saving some can put you in a much more precarious financial position than someone who does carry a lot of debt but also has savings.

"The importance of having cash on hand for the unexpected expenses of life is something that we really need to get back to," says Vyse.

For instance, if you have no savings and your car breaks down, he says, "you have no choice at that point. You're going to go into debt to pay for that repair."

A person with savings can absorb much more because he can use his savings to pay for emergencies, plus fall back on credit.

"So they have, in a sense, twice as much safety in emergency situations," Vyse says.

Keep in mind that you do have control over your own financial situation -- if you exercise it.

"Everyone thinks that it was the event that threw them into financial distress," says Gail Cunningham, senior director of public relations for the National Foundation for Credit Counseling. "It was the visit to the emergency room or the leaky faucet or the washer going out that put them over the edge. But it wasn't. It was lack of preparation that caused that to happen.
"As soon as we think we have our ducks in a row, the bottom is going to fall out."

Copyrighted, Bankrate.com. All rights reserved.

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