Q: Why is it that people tend to end each year with the same amount as when they started?—posted at PFA’s “ask a friend, ask Efren” service at www.personalfinance.ph
A: Since the “ber” months inevitably lead to Christmas, I will start my reply with a quick story about Santa Claus and his reindeer.
On a pre-flight check one Christmas eve, an elf came up to Santa to double check whether all of the reindeer had clocked in. The elf asked Santa for the total number of reindeers. Santa, the man with a belly like a bowlful of jelly, joyfully exclaimed, “Why, there are nine: Dasher, Dancer, Prancer, Vixen, Comet, Cupid, Donner, Blitzen and, of course, Rudolph.”
The elf replied, “But Santa, I counted 10 reindeer? Look, the tenth is standing behind Rudolph. The others say that this tenth reindeer used to be a bully to Rudolph.” After stroking his beard and scratching his head, Santa replied, “Ah yes, that one. I have seen him before but I can’t seem to remember his name now. But I know it is Russian sounding.”
I’ll complete the Santa story later. For now, let’s focus on your question.
The “ber” months can actually be interpreted as the “brrrr” months because this is the season when it gets colder in the Philippines. In the US, stock market crashes used to happen in the fourth quarter, making the last three months of the year the bear months.
For the most part, however, it is during the “ber” months when people end up bare, financially speaking. The 13th month pay is already allocated to pay for debts contracted earlier in the year. To some, even the yearend conversion of sick leaves had already been collateralized to fund summer fiesta celebrations.
Actually, the practice of getting one time, big time funds to pay off debts is a good strategy. The only problem is that the practice of spending a lot early in the year in anticipation of windfall earnings during the “ber” months becomes a never-ending cycle. This problem has two components: 1) people know they have future income but they just don’t know how large it can get; and 2) without any idea of how large future income can be, people spend just as much as they expect to earn within the foreseeable future (commonly a year).
Consider a 21-year-old earning P10,000 a month for 13 months in a year and who will retire at the age of 60. Assume further that this person’s income will grow by 5 percent a year due to merit increases. Finally, assume that this person will receive a retirement pay equivalent to one month’s salary for every year of service. This person stands to earn an absolute income of over P17 million throughout his career.
The income would still be worth over P6 million if we were to value it today using a 4 percent inflation rate as the discount factor. And if we were to work backwards and see how much this income would have been worth when the person was merely one year old, the value would still be nearly P3 million.
People have a tendency to spend away loose change. I have not seen any accounting principle that supports this behavior. But behavioral economists attribute this spending pattern to the fact that people do not put too much value on loose change. A P20 bill is much easier to spend than a P1,000 one. And this is precisely how people see their income in the foreseeable future (i.e. one year)—as loose change.
If only they are able to go beyond one year and see the big picture, people will realize that they are multi-millionaires. They will burst into song with, “Look at this trove, treasures untold.” And they will tend to spend it more wisely.
If people were to save and invest a portion of their future income, they will even end up with much more assets. But do remember that the state is everyone’s passive partner in creating wealth. Therefore, once these assets are passed on to heirs, there will be taxes involved, even if taxes were already paid in accumulating the wealth. That is why estate planning, which provides options on legally minimizing transfer taxes is also very important.
Be both joyful and triumphant in accumulating wealth and passing it on to your heirs, by attending the EnRich™ personal finance training runs happening in Cagayan de Oro, Angeles, Cebu, Davao and Manila. The EnRich™ Cash, Debt, Risk and Wealth or CD-RW module is for free while the EnRich™ Estate Planning module is for a modest fee. E-mail info@personalfinance.ph or SMS 0917-505-0709 for the details. Details for the training may also be found in www.personalfinance.ph.
Back at the North Pole, Santa finally remembers the 10th reindeer’s name. “Why yes, the name is Olov,” Santa gleefully says, “Olov, the other reindeer—used to laugh and call him (Rudolph) names.”
(Efren Ll. Cruz is a registered financial planner of RFP Philippines, personal finance coach, seasoned investment adviser and bestselling author. Questions about the article may be sent by SMS to 0917-505-0709 or emailed to efren@personalfinance.ph. To learn more about the RFP program, attend a FREE orientation on September 11, 2014, 7pm at the PSE Center. Email info@rfp.ph or text <name><e-mail><RFP> at 0917-3464126 to register.)