Yet another year is coming to an end and it is finally time to confront some of our toxic financial habits. Many of us often do not stop to consider how frequently overspending on accessories, clothes, or parties can affect our finances. We often do not plan out anything and simply spend spontaneously but perhaps 2020 can finally be the year that some of us can reconsider our financial habits. Let us have a look at some toxic financial habits that need to be left behind.
#1 Not Understanding Opportunity Cost
The concept of opportunity cost can prove to be quite useful in decision making. An amount of money, for instance, can either be put into savings, an investment portfolio, or even used to make a purchase that would give future returns, such as upskilling training. By definitely, opportunity cost refers to the cost of the next best alternative that is forgone. Therefore, buying that fancy new gadget today also comes at the cost of not using that amount on the next best alternative, such a SIP investment or education.
Consider an example – if you spend using credit cards and are paying a credit card interest of 18% annually, whereas your investment yields a 7% annual return, then you are facing a net loss. Therefore, gaining an understanding of how opportunity costs work can be a beneficial financial habit that will help in the long run.
#2 Working Without a Plan
Not having any financial plan and spending recklessly is another toxic financial habit that you need to leave behind. Having a well-crafted financial plan can help you set targets, plan investments, and design portfolios according to your risk profile, thereby allowing you to achieve your financial goals. This also includes having a good safety net or insurance plans, investments with high liquidity for emergencies, tax planning, etc.
Many of these may look like they are unnecessary or that they are not worth the effort but small changes in your financial habits can result in large benefits.
#3 Emotional Spending
Emotional spending or impulsive spending can be yet another toxic financial habit that can potentially wreck your long-term plans. Spending all your income on non-essentials like too many parties or trips can be disastrous sometimes. Therefore, it is always best to have a budget. Budgeting should be an important part of any salaried person’s life.
Quite often, people end up surprised when they realize how much they have spent during the year. Setting up a reasonable budget with adequate room for a little extra spending can solve many of these problems.
#4 Not Giving any Thought to Savings and Investment
Saving and investing is crucial to everyone’s life. Many young people might think that they can always start investing later and a few initial years of luxurious spending would not be a problem. But such an approach can result in a lot of missed opportunities and returns that you may regret later.
Consider person A, who invests $5000 every year from age 25, and stops at age 34. Another person B starts investing $1000 annually from age 35 but continues investing until they’re 65. This ten-year difference could result in not just a $20,000 overall deficit (with the 2 decades of extra saving person B does), but an exponential difference between their returns many years later because of the principle of compounding.
Source: Federal Reserve Bank of St Louis
#5 Getting Lured by Seemingly Attractive Offers
Sometimes offers that involve loyalty points and premium memberships can end up, resulting in a net loss for you. For example, if your credit card company is offering you reward points for every $100 you spend, then you may be enticed to spend even more just to earn those reward points without realizing that it results in a net loss.
Another example can be a premium e-commerce store membership that might cause certain customers to spend even more to compensate for the membership fee. While this does not mean that all such offers result in loss, it is definitely worth analyzing what your gains and losses are when it comes to such situations.
Your Financial Habits in 2021
It is an open secret that discipline is the key to a successful financial plan. Many toxic habits are a result of a lack of understanding of how everyday decisions can have larger effects on our lives and how small behavioral changes can greatly benefit us. However, even financial discipline need not be taken to the extreme because not allowing yourself to spend on anything for a bit of fun can also lead to stress. In any lifestyle, figuring what is best for you, and creating the perfect balance is essential.