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  • William Seah

Why All Financial Decisions are Emotional Decisions (and what we can do about them)

All financial decisions are emotional decisions.

This rang especially true when I read the article by The Straits Times, “World’s biggest luxury spenders are label-loving South Koreans”. Nothing captured how all financial decisions are emotional decisions better than this discovery:

“Helping to fuel the surge was South Korea’s runaway housing boom, which saw property prices in some cities double during the pandemic, making homeowners feel wealthier. ”
- The Straits Times, 26 Jan 2023

A lot of our spending decisions are influenced by our current situations and how it makes us feel, and small nudges like this can greatly influence our spending habits. So how do we ensure that our financial decisions are not fueled by pure emotion?

Distinguishing between Asset Types

Why did homeowners spend on luxury goods even though they had little cash on hand? Soaring property prices made them feel wealthy. The case study on Koreans showed us that when we feel rich (even though we aren’t actually rich), the feeling of being rich is good enough to trigger changes in spending patterns. What makes it worse is when asset values go up for some time, there is a tendency to believe that this would continue. We all know logically that booms and busts are part of any economy, but we act as though crashes will come another time and we can prepare for them.

In fact, we should be wary of how we view our wealth, especially when it involves property ownership - while the value of this asset increases, it does not actually make us wealthier as we cannot unlock the value of this asset, since we stay in our homes. A property that you live in has monetary value, but accessing it entails major changes in your life. If you were to sell it, you’d need to find alternative lodging, along with all the associated struggles with moving thrown into the mix. If you were to rent out your property, you need to share your home with a stranger. In fact, property that we own and live in is termed “Personal Use Asset” and this class of assets should not be confused with the conventional idea of an asset. The best way of thinking of assets is anything that has a monetary value that can be easily accessed and does not change your life in any way. Pure investments that are not of personal use do not cripple the way you live.

Irony in Rising Property Markets

Even if you aren’t a property owner, the sense of wealth seems to spread to the community and trigger even more emotionally fueled decisions on our finances. There is no greater irony than the flip side that the Korean property market presented:

“On the flip side, younger South Koreans despairing they would never get on the property ladder decided instead to spend their income on luxury treats.”
-The Straits Times, 26 Jan 2023

The very same asset appreciation led to people being unable to afford a home, yet feeling wealthy, and choosing instead to reallocate their money on luxury treats.

This presents a real threat. Money is fungible. It can be repurposed towards other goals. This is an incredible strength of money, and yet, also its weakness. I have an iPad and for all the wonderful things it can do, replacing paper in so many ways, it cannot replace toilet paper. But money set aside for retirement in a year's time could be repurposed for a holiday today, a set of jewelry tomorrow, and a brand new set of golf clubs the day after. For goals that require long-term planning, we become myopic; short-term wants supersede long-term needs.

In the case of younger South Koreans, what would happen when they age and lack a proper home over their heads? Owning and living in a property allows you to be protected against rent inflation, and having a safe space does wonders for your mental and physical health. By believing they are excluded from the housing market, instead of setting the funds aside to ensure they have housing in the future, they choose instead to buy luxury treats. While a “1.6 million won Marni handbag” might make you feel happier now, I doubt it will keep you warm when the winter is upon you.

While Singaporeans are not at that stage yet, it is good to learn from Korea and ensure we don’t fall into the same predicament. So what can we do to ensure that not all our financial decisions are fuelled by pure emotion?

1. Distinguish between wants and needs

Firstly, be clear about your wants and needs. Wants are nice to have, and it might feel good to show up with branded goods. But do ask yourself if there is a need to keep up with the Jones. Afterall, owning the latest Louis Vuitton handbag doesn’t make you a better person, although it does help LVMH’s CEO become the world’s richest man. Of course, we shouldn’t deny ourselves everything, but overindulgence leads to more issues. Therefore, having clarity about what we want and what we need, and in relation, what we can afford, can help us to make better decisions on our spending patterns.

2. Fight Lifestyle Inflation

Secondly, fight ‘lifestyle inflation’. Inflation is not something most of us are unaware of. In fact, we are in the midst of one of the higher inflation periods in recent times. While we cannot avoid inflation entirely, we can avoid lifestyle inflation. That is when we choose to ‘upgrade’ our lifestyle, from dining at hawker centers to heading over to a nice restaurant. When previously we would be happy with wearing clothes from a couple of seasons ago, we now need the latest trends set by Milan. When we hunger for the latest gadget or get rid of things just because the item is mildly used. Lifestyle inflation creeps up on us and results in us spending more on things, to get more things. Fighting this urge can help us to ensure that our money is being channeled to our long-term goals.

3. Clarify your assets: Monetary assets vs. Personal Use Assets

Thirdly, be clear when you are truly ‘richer’. There are two main classes of assets, one being Personal Use Assets and the other, being Monetary Assets.

Personal use assets are assets that you use in your day-to-day life. Personal use assets have monetary value but unlocking the value typically means changing your lifestyle. It is important that you do not allow yourself to be swayed by the lie that you live in a million-dollar HDB and therefore deserve a million-dollar lifestyle. The value of your HDB might have shot up, but you cannot access it easily.

Monetary assets, on the other hand, can be liquidated to provide you with funds. But be warned, while such assets can appreciate (e.g. the stocks or unit trusts you own), do note that these assets can also depreciate (such as crypto which has made people cry, either tears of joy or tears of horror, over the last few years). When making decisions, recognise that these assets fluctuate in value over time.

In today’s increasingly volatile world, our attitudes need to change. Long-term employment is starting to be less common, given the disruption occurring in every sector. Inflation is starting to creep in, even without Covid, as people become more demanding and resources become more scarce. Luxury items might bring us a moment of joy, but don’t let them become a lifetime of sorrow. Things are nice to have, but peace of mind is a much better place to be. The next time you have the urge to splurge, pause and reflect on what emotions are driving it and if you can afford it.

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