As I was writing my previous post about changing your mindset to increase your savings rate, I touched upon the idea that luxury goods consumption is counterproductive to building net worth.
This got me thinking…
Whether or not us frugal FIRE people like to admit it we probably still enjoy luxury goods and services. So, is there way to do this without compromising our journey towards financial freedom?
Mathematically the answer is simple: consume luxury goods sparingly relative to income i.e. only consume up to a point where your savings rate is not compromised. In reality though, our own psychology can be our worst enemy so we need to understand it in order to work towards the simple answer.
To provide some thoughts on this, let me provide some context around what luxury and services goods are.
According to the Collins dictionary luxury goods are things which are not necessary, but which give you pleasure or make your life more comfortable. For the purpose of this post I’m going to extend this definition to services as well.
Ok onto my thought piece
Let’s talk about why people desire luxury goods and services in the first place.
Status and signaling
Luxury goods are used as status symbols, which can be used to convey the desired signal about the user such as status, wealth and exclusivity (McFerran 2014). It is also suggested that they play a role helping us attract mates (Mehta 2014). Both of which probably helped our ancestors reproduce which, over the generations, has ingrained the behavior into our psychology.
Symbols of achievement
It’s not uncommon to use expensive luxury goods as a symbol of achievement or a reward for hard work. Now this can be simply for one’s self or to display to others. I know a guy that bought himself a luxury automatic Swiss watch once his net worth surpassed a certain value.
The products are perceived to be better
People have the perception that the quality of things increases with price. In a study where the same bottle of wine was marked with varying prices and then served to volunteers the subjects reported that the allegedly more expensive wine tasted better. Their resulting brain scans somewhat implied that the neural pathways linked to motivation affect sensory experiences (Schmit, Skvortsova, Kullen, Weber, Plassmann 2017).
Happiness and belonging
Relationships are a key to being happy in life. Often purchasing luxuries can bring a sense of belonging to the user similar to an entry ticket to an exclusive club. Think about a business class ticket giving you access to the lounges where staff care for you or owning a Harley Davidson and being able to go to the club events.
Changing our mindset to reduce luxury goods and services consumption
By now we should know that luxury goods and services are in excess of what we need and are counterproductive to building net worth and the financial freedom journey. However, if consumed in a limited manner relative to income, luxuries can be enjoyed without hindering a journey to financial freedom. Now that we have some understanding about why we consume luxuries we can use this information to shape our mindsets towards financially sustainable consumption.
Avoid signaling, your wealth is for you to enjoy
I believe seeking status is a very hollow pursuit. I’ve taught myself over the years to care less about what others think of my ownership of (or lack of) status items. This is backed by my belief that what really matters is real net worth and financial freedom. The idea that I’m working towards a goal that is so meaningful to me every day elicits more positive emotions than I could ever gain from trying to signal that I’m wealthy.
I also understand that when people choose to display luxury goods/status items to convey traits such as success or wealth, other peoples’ inferences about user’s character vary greatly (McFerran 2014). Every now and then I think that owning a Porsche Taycan (my dream car) would mean people think I have good taste and are a successful person. In reality there are probably as many people inferring that I am successful as there are people that think I’m a faux tree hugging asshole. The lesson here is that purchasing luxury goods to impress others is pointless, the only person that you need to impress is yourself
Symbols of achievement as motivation
Following on from my previous point, I am not averse to using luxuries as symbols of achievement, but only for myself. When tied to metrics of net worth or passive income these luxuries can serve as a source of extrinsic motivation. Even though they are not as strong as intrinsic motivators, when used in this way I feel that some level of alignment is achieved with a goal of achieving financial independence. The key is to size them appropriately relative to your goals. For example, a $5,000 watch would be a good reward for reaching $250,000 net worth but would be too large if rewarding yourself for building up your 6-month cash savings buffer.
Purchase for utility
Sometimes luxury goods are actually better, but make sure that you evaluate your use case thoroughly before falling for the same trap as the wine subjects above. For example, if your passion is digital art then it can be well worth it paying for a large monitor with excellent color reproduction. Understanding your use case is particularly important so that you can shift your purchasing away from status signaling towards purchasing for utility.
Scarcity helps create value
Limited edition products are used by companies all the time to create scarcity and exclusivity. This generally results in a situation where demand is less than supply which means price rises to suit. This effect exists because consumers place a higher value on goods that are scarce (Chen 2020). As savvy consumers we can use this to our advantage by choosing to make our own luxury goods scarce. If we choose to purchase infrequently and limit the number of luxuries consumed, we are forced to value them more. For example, owning a single luxury handbag would force you to value it more than if you owned 20.
Use frequently
Since I’m a big fan of cutting out waste, then if you intend on buying luxury goods then make sure that they get used frequently and you treasure the value that they bring. This helps you to realize that you don’t need other items which minimizes wasted spending. For example, I own an expensive fitness tracker/watch which I use every day. I have also made a conscious choice for it to be the only watch that I wear which effectively eliminates my desire to additional watches.
Concluding thoughts
Luxury goods and services can be part of a healthy spending budget if they are purchased sparingly relative to income. The key thing to understand is that they represent excess in our already abundant lives. I believe that by understanding the psychology around why we desire luxury goods and services we can make more informed/conscious decisions as opposed to falling victim to our own psychology.
Engineer your freedom
References
Collins 2020, Definition of ‘Luxury goods’, Collins Dictionary, last viewed 10/10/2020, <https://www.collinsdictionary.com/dictionary/english/luxury-goods#:~:text=Luxury%20goods%20are%20things%20which,fur%20coats%20and%20expensive%20cars.&text=Drag%20the%20correct%20answer%20into%20the%20box.>
McFerran, B, 2014, Why do we buy luxury brands – and how do they make us feel?, Psychology Today, last viewed 6/10/2020, <https://www.psychologytoday.com/au/blog/ill-have-what-shes-having/201405/why-do-we-buy-luxury-brands-and-how-do-they-make-us-feel>
Mehta, V, 2014, What Do Your Designer Clothes Say About You?, Psychology Today, last viewed 6/10/2020, <https://www.psychologytoday.com/au/blog/head-games/201406/what-do-your-designer-clothes-say-about-you>
Schmit, L, Skvortsova, V, Kullen, C, Weber, B, Plassmann, H, 2017, How context alters value: The brain’s valuation and affective regulation system link price cues to experienced taste pleasantness, Nature, last viewed 10/10/2020, < https://www.nature.com/articles/s41598-017-08080-0>
Chen, J, 2020, Scarcity Principle, Investopedia, last viewed 11/10/2020, <https://www.investopedia.com/terms/s/scarcity-principle.asp>