The all powerful zero

Question: if there is one advice you can give on controlling spending, what would that be? asked at “Ask a Friend, Ask Efren” FREE service at www.personalfinance.ph, SMS and Facebook

Answer: Contrary to conventional wisdom, zero is the most powerful number in personal finance. From the point of view of spending, zero can mean no cost. From the point of view of saving, zero can mean no losses in standard of living despite the act of setting aside cash for future needs. In both cases, zero means the avoidance of a loss.

Behavioral economists say that many of the reasoning that transpires in our brain has been in existence since man first appeared on the planet. Much of that reasoning was devoted to survival, which when put in another way meant the avoidance of losses to life, limb or property.

Even as humans evolved, the early rules on survival remained ingrained in the human psyche, just modified slightly to adapt to modern times.

Take the case of installments on zero interest. It is difficult to imagine a lending company giving out loans with no interest. A basic tenet in economics is that you sacrifice consumption now only to enjoy a greater level of consumption in the future.

The trick lies in the pricing of the suggested retail price or SRP. In many 0-percent installment schemes, the SRP already includes the interest, with the SRP then simply being divided by the term of loan. Retailers are actually empowered by the Consumer Act of the Philippines to adapt the 0-percent installment scheme because the law requires that only one price tag is to be displayed, no separate cash and installment prices. Thus, the interest on the so-called 0-percent installment scheme can be neatly tucked away in the SRP, hidden in plain sight of the unsuspecting consumer.

The sure-fire way of determining whether there is truly interest or not in this scheme is to ask the seller if there is a cash price that is lower than the SRP. If the seller says yes then there is interest. Of course, the seller will not go down without a fight. He will say that the only reason why the cash price is lower is that  he is offering a discount for receiving cash upfront. He knows that by using the word discount, he will be eliciting a positive reaction from you, again, avoiding a loss (i.e. that of interest expense).

But the reasoning above is an admission that the SRP is indeed inclusive of interest. Now, if you have the cash to spare, pay cash. If you do not have the cash, then accept the fact that you will need to pay interest.

On the other hand, saving actually bears a negative connotation simply because the brain interprets it as a reduction in the amount of money that can be spent and enjoyed. And even when savings can have an overall positive impact on finances, especially for the future, the brain treats gains as gains and losses as losses. Saving, to the brain, represents an outright loss.

The better way to save is to do zero-based budgeting where you create a budget from scratch. That way, there is no way of perceiving an outright loss. So, instead of saving a certain percentage of your income, you will try to live off the complimentary percentage of your income, the latter being perceived by the brain as a foregone gain.

So, you see, zero is an all powerful number in personal finance precisely because it means nothing, especially when zero is used to mean no losses.

Learn to use the number zero to your advantage.