Several decades were to pass, and many vicissitudes to be undergone, before I could master the simplest and most important of all the rules of material welfare: The most brilliant financial strategy consists of living well within one’s means. – Benjamin Graham, The Memoirs of the Dean of Wall Street
The ability to defer gratification by chronically under-spending income is a necessary step to building wealth, highlighted famously by Charlie Munger when he said “The first $100,000 is a bitch”. In order to have capital to invest, a person starting from zero must accumulate it by spending less than he makes and investing the difference. The more you can under-spend, the faster you can build wealth. This idea of spending less than you make is known as The Micawber Principle., originating from the book “David Copperfield” by Charles Dickens where a character, Mr Micawber principle offers this advice to young David.
Annual income twenty pounds, annual expenditure nineteen, nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
The reason for this has to do with another concept – The Hedonic Treadmill
The Hedonic Treadmill
The Hedonic treadmill or Hedonic adaptation states that as a person gains money, expectations and desires rise in tandem resulting in no permanent increase in happiness. For most people, this means that as they raise their standard of living by buying a bigger house, car etc their happiness reverts to normal levels pretty quickly. However this new standard of living becomes the new baseline, and they now have to run harder in rat race to maintain it. You wonder why so many of the rich don’t always seem proportionately ecstatic? It is because they have completely acclimatized to having all that material comfort to the extent that most of them can’t imagine life without it.
In fact, if you even tried to suggest to someone that they should downsize their standard of living, it will likely be met with extreme resistance. This has something to do with what Charlie Munger called “Deprival Super Reaction Syndrome” which states that when you try to take away something from someone and their response will be disproportionately irrational. Try taking a bone away from a dog and you will see what I mean.
When you think about certain billionaires like Warren Buffett whose expenditures are downright paltry compared to their wealth, you realize that they have spent their entire lives completely refusing to run on this treadmill. For them money is merely a scorecard for how effectively they are doing something they enjoy well, and a way to influence society in a positive manner (Buffet once called it “claim checks on society”).
The ultimate benefit of money to an individual is thus as an enabler – giving a person both the time and options to structure his or her life in a manner that would maximize quality of life and satisfaction. Spending it just to keep up appearances with the neighbours or because society expects you to live in a certain manner is the height of silliness, as are people who tell you that life is to be enjoyed while implying that you need to spend money to do so. It isn’t, our consumer driven society just has you programmed to believe that you are missing out if you aren’t buying the newest toy or taking the most expensive vacation. I think that social media has made this worse, with people posting idealized versions of their lives online making other people feel that they need to compensate to keep up. There is usually an uglier side to the story – The debt taken on to finance the flashy lifestyle, the countless hours of late nights, crowded airports and tyrannical bosses in that coveted job.
I conclude by saying that it would be wise to remember the adage – “Money is a wonderful servant but a terrible master”.