Rational Behavior Education and Your Budget

In the world of economics they have the concept of “Homo Econimicus” or “Economic Human.”   This concept indicates that humans are rational beings that act only in their best self-interest.  This is typically used to explain markets and economic theories but in most circles, especially the academic and professional/political circles, it is a quite predominant perception of how humans act in regards to their personal finances and economics.

Well, a lot of education on how people should behave has a very similar approach.  I call it the theory of “Rational Behavior Education.”  My theory on this is that most education is based on the idea that humans are totally rational and if provided with a good rationale as to why a behavior should be changed, the human will naturally see the benefit of such a change and quickly adapt the new behavior.

Let’s take smoking for instance.  We all know smoking is bad for human bodies.  But most education is focused on discussing the fact that it is bad for us, by telling us all of the negative side effects of smoking.  I was a pretty extreme smoker for over ten years and this is what people would tell me over and over, “Your lungs are black, your breath smells, it costs a lot of money, it makes your teeth yellow, it causes cancer, oh, and you could die.“  Now, I know at one point in time, people did need to be convinced that smoking did harm to their body, but that time is long gone.  We know it.  We have heard it for decades.  We know!  But if we were totally rational humans focused solely on our own best interest, we would see quite clearly that smoking is not good for our body, costs a lot of money, makes us smell (which could prevent potential mating possibilities, maybe), and make our teeth yellow, makes our clothes smell and so on.  We would see all of that and we would stop. But do you see the problem?  Yeah, we’re not rational.  Humans can be rational.  We can be unbelievably rational creatures.  We may be, perhaps, the most rational beings on this planet – maybe anywhere in the universe. But we are not ALWAYS rational.  And educational efforts about behaviors aimed solely at our rationality that neglects to touch on how irrationality and emotion plays a significant role in our behaviors will be minimally effective.

In the world of Rational Behavior Education, if we could just teach everyone how to create and manage a budget, a person’ personal financial life would be sunshine and happiness.  But telling people that smoking is bad for them and that they should budget their money is only occasionally, mildly effective.

 

Time Value of Expenses

How much time and energy, in terms of work hours, does it take you to pay for housing, transportation, food, health insurance, car insurance, or entertainment?  Do you know?  If you are like most people, you may have thought about this as it applies to some of your expenses.  Or not. In either case, I have found that when people begin to apply the following exercise to their expenses, they tend to see how or if their expenses are really in alignment with their values in an even deeper way than when they did the receipt exercise.

Here’s an example of how it works.  The other night I took my oldest son out to dinner and to see a movie.  We went to a nice little restaurant.  Not too expensive, but definitely not the “value meal” at the local fast food joint.  The total cost of the meal with tip was around $45.  Movie tickets for the two of us cost $24.  The “Value Package” snack we bought at the theater cost $15.  Total cost for the evening totaled $84.  Now if I’m making $10 per hour and the night out cost $84, then the time cost, in terms of work hours, for the evening out with my son was 8.4 hours.  Well, I know that I work approximately 8 hours each day and so the cost of the evening out was slightly over one of my work days.

In addition to being a good chunk of change, that’s a lot of time and energy. When we pay for rent, mortgage, dinner out, movies, or anything else for that matter, not only does money leave our possession, but so does the time and energy that money represents.  Whenever we spend money, we also spend our time and energy.  And like money, once that time and energy is spent, it cannot be used for anything else.

Of course, using the same example above, we could break out each expense separately as well.  The meal was $45.  If I divide that by $10 per hour I would see that the meal cost me 4.5 hours of work.  The movie was $24, divided by $10 per hour and I would see that the movie cost me 2.4 hours of work.

To calculate the time value of a particular expense, you take the amount of the expense and divide it by the hourly wage you listed above and you can figure out how many hours it takes to earn that expense.

Now, let’s take a different expense.  Say for example your food costs $250 per month and your hourly wage is $10/hour.  Divide $250 by $10 and you will see that it costs 25 hours of work time.  Of course, I’m using simple round numbers to demonstrate and your numbers might not be so simple and round.  No problem.  You can either do the exercise with your exact numbers using decimal points and all, or you can round up or down.  I’m not looking for perfect calculations – this is not a math class!  I just want you to get a better idea of how much of your work time is devoted to your expenses.

How Much Are We Really Spending

People typically think of rent or mortgages as monthly expenses since, after all, we pay those expenses on a monthly basis.  In actuality though, we are paying for every hour, every minute, every second, EVERY MOMENT, of every day. For example, if a typical month has 31 days and there are 24 hours in each day, then the number of hours in a typical month equals 744.  If my rent costs $1,000 per month, I accrue approximately $1.34 in rent per hour and approximately $32.26 per day.

Calculating rent, or mortgage, utilities, credit card bills, grocery bills, etc. down into an hourly or daily amount might not sound like a lot of fun, and my goal here is not to turn you into a human calculator or to persuade you to spend an exorbitant amount of time calculating every single one of your expenses in this way.  I simply want to raise awareness about how much money is really flowing out of your possession, so often without your awareness or knowledge, at any given hour or on any given day.

Perceptions of Income – Gross v Net

We need to take a moment to discuss your gross income versus your net income.   In case you don’t know, your “gross” income is the full amount of a source of income (like your paycheck) before taxes or any other deductions are taken out.  After they take the taxes and deductions out of your source of income, you receive what remains and this is referred to as “net” income.  As an example.  If your hourly wage is $10 per hour and you work 40 hours during the week, your gross pay is $400.  But when you receive your paycheck, you notice that it is only $350. That is because they have taken out all of the taxes.  The gross pay was $400, the net pay was $350. Pretty straightforward, right?

Okay, so this is where a lot of programs leave this information.  There is money that is “taken out” of your paycheck and you should know the difference between “gross” and “net.”  But there’s some important information that is being left out, and in my efforts to eliminate our tendency to DISCOUNT the value of anything, we need to look at this just a little bit longer and perhaps from a slightly different perspective.

First, it is very important that when we look at our hourly wage or salary that we give it the total value.  For instance, in the example above, you earned the full $400 and we want to recognize the full amount.  But what happens is we tend to focus only on the net income because that is what you are going to use to pay your bills.  There is a tendency to think of the money we didn’t receive as being “taken out” – which is only part of what happens.  That money is taken out, but it is used to pay for something.  That is to say that you are actually spending that money.  You are spending that money on a lot of things.  Some of it goes to pay for roads, police, military, libraries, schools.  Maybe some of it goes to pay for your health insurance or a retirement account.  Maybe some of it goes to child support.  Wherever this money goes, it is you that is spending it and we want to recognize that it is our money that is leaving our possession.

The point of this discussion is not to argue whether your tax money is being spent well, or what is fair or right, or who is to blame for anything.  The point is to illustrate that the money between “gross” and “net” is money that is spent on goods and services.  It is money that you earned and we do not want to DISCOUNT the value of those resources by not acknowledging them.   So, yes, the money is “taken out” but then it is paid to someone else.  It is not something that is happening to you, it is a process in which you are actively participating.