Most people have heard the phrase ‘Penny Wise, Pound Foolish’ but have you been guilty of it? The phrase refers to people who do whatever it takes to save a few pennies (cents) and will blindly make a major purchase without thinking twice of the financial consequences.
From my experience, being penny wise and pound foolish is a psychological trick of math and this leads to people squandering their hard earned cash. Lets think it through.
1 – Penny Wise
If we see something advertised at say $1.00 and then see it at another shop for $1.20, we immediately know that the price is 20% dearer. So why waste 20 cents on the same item? The 20 cent saving sounds like a lot because it is 20% of the original price.
Now, lets think about this some more. If you save 20 cents five times a week, your weekly saving amounts to $1.00. Do this each week, you save $52.00 over 12 months.
2 – Pound Foolish
Mistakes are made because we tend to lose sight of small percentage differences. The best examples of being pound foolish happen with motor vehicles.
Mistake one – Buying a brand new car
As soon as you drive off the forecourt, the value of your car will depreciate (lose value) and over three years the typical loss is around 50% (Refer MRMA What Is vehicle depreciation). And from the NRMA study, it seems the more expensive the car, the greater the loss.
Let’s put the new car purchase into perspective. If you bought a medium car for $50,000, the depreciation over 3 years is 55%. The loss is a staggering $27,500 which equates to $9,167 each year. Or to look at it another way, over $176 each week. Think about that for a moment A new car will cost $176 each week before fuel, servicing costs and insurances.
They don’t mention this $176 a week depreciation loss in any new car advertising
One could argue that you need a car, but do you need a new one? If you bought this $50,000 car off the owner three years later, you would get it for less than half price. Keep it for three years and your loss would be substantially less. Even if you lost the entire value, it would still be a smaller loss than what the first owner suffered.
Mistake 2 – Buying extras with that car
When you buy a small item, you can quickly calculate the percentage variance, so 20 cents extra from something that costs a dollar sounds expensive. But when we add on $3,000.00 for a car that costs $50,000, that $3,000 does not seem like a lot. It is only 6% extra. But, $3,000 is just under $60.00 a week. Go ahead and save every penny you can find and you’ll struggle to save $60 a week.
Mistake 3 – Getting into a situation when you can’t stop spending
People often fall for this big mistake on holidays and at Christmas time. How many times have you started spending and kept spending because each extra dollar spent seems small compared to what you have already spent? It probably happens more often than you think and to make matters worse, the extra spend often ends up on the credit card at very high interest rates and fees.
To avoid this trap, set a budget for your holidays and Christmas. This might sound a bit boring, but coming home from holidays to face a big credit card, can soon ruin all those wonderful memories.