You are excited, perhaps even amazed at the idea of having your money work for you. You are committed to save more money this month because after all, each dollar you save is going to work hard to produce more dollars. You want to go through the month determined to spend only on the necessary stuffs.
By month’s end, you realize you have spent almost all of your income.
If this sounds familiar to you, you are not alone. There are millions of people just like you who discover to their dismay they have spent most of their income by the month’s end. And they never seem to grasp how all that cash just disappeared.
By the time you finish this post, it won’t sound anything like a surprise.
Cyril Northcote Parkinson, the famous British historian and author, in 1955, observed something phenomenal about bureaucrats which he published in a column in Economist. The opening line of that column caught attention of the academia and came to be known as Parkinson’s Law. For those of you who don’t know, it goes something like this :
Work expands to fill the time available for its completion
Though Parkinson meant to depict the flaws in bureaucratic administration, it became widely regarded as a revelation to a productivity flaw that lies in each one of us.
It’s easy to see Parkinson’s law at work in your daily life. Just think of a job that took an entire week to complete even though you initially thought it might take just a few hours. Or think of that project that never gets completed simply because there is no deadline. As a college student, I always find myself finishing my assignments just at the last minute.
How Parkinson’s Law Affects your Finances
As much as this law tells us about our inadequacy in managing time, it reveals our shortcomings in managing our expenses.
How about we modify the statement to the following :
Expenditure rise to meet the income available.
I guess you know where we are getting.
Remember the last time you got your salary increased, and you rejoiced on the opportunity to save a little bit more, thus fastening your way to retirement.
But what happened?
You probably got yourself a new cable, or scheduled a vacation somewhere, or simply spent it dining out in a nice restaurant. Before you could realize, all the extra cash just vanished into the oblivion. Very soon, similar needs and wants started cropping up every single month and somehow they appeared to be just as important as food and shelter, demanding your extra cash. In no time, you discovered that your budget had expanded to fill the extra income that was available before.
It happens time and time again, and yet people never consciously think about it. It also explains why the rich get richer while the poor get poorer.
An increase in income presents the financially smart people (the rich) with an opportunity to compound their savings to a bigger amount.
On the other hand, as the income of the poor people increases they take more obligations on their shoulders. They buy a larger house, get a better car or bigger television.
No wonder such behavior causes poor people to remain poor no matter how much they earn.
Using Parkinson’s Law To Your Advantage
Its now clear that the difference between rich and the poor lies not so much in how much money they make as in how they use their income. Quite simply, financially intelligent people use Parkinson’s law to their advantage. Don’t worry if you think you need to be gifted to be financially smart. Because you don’t. Financial IQ has more to do with your temperament than your intelligence. And therefore, by following these simple steps, you can turn the table and dramatically increase your savings (and eventually your net worth).
#1 Pay Yourself First
Perhaps the most important step you can take before your mind tricks you into giving in to Parkinson’s law is pay yourself first.
The rich do that all the time. That’s why they are rich.
It simply means before you spend a single dime of your income, you put a chunk of that money in an account you won’t ever touch until your retirement.
Do not save what is left over from your income, spend what is left over from your savings.
As you do that, you will discover your expenses will dramatically shrink down (Again Parkinson’s Law At work). How much you should take out really depends on how much you make and how soon you want to retire.
What you do with your savings depends on level of your financial education. Ideally you should invest that money in assets. If I were you, I would buy undervalued stocks of great companies, thus multiplying my net worth with greater speed than average people. But you might wanna put it in a safe until it grows enough to become down payment for equity in a real estate property. Check out these 10 alternative investments if you think picking individual stocks is risky.
#2 Budget Everything
One of the biggest financial mistakes you could be making is not preparing your monthly budgets.
The importance of budget can’t be stressed enough. They tell you where your money is going and help you decide if it makes sense for the money to flow as such. Most people do not discover how much money they spend on things of little importance unless they prepare a budget.
It is therefore essential that after you have paid yourself, you prepare a budget that includes the all possible expenses. Follow these steps to prepare the budget :
- Start by writing all the possible expense you are expected to have for the month. Include every single bill, debt payment, even movie tickets you might wanna buy during the month.
- Categorize those expenses as ‘avoidable’ or ‘essential’. (Or need based expenses and lifestyle based expenses). As you do that, remember to cut off any expense that you think would not add significant value in life (by which I mean expenses that you incur only because of your pride or social confirmation).
- Now start filling money in each row of the essential expense column. Do not touch the lifestyle based expenses yet.
- Now that your essential expenses are covered, take some money out and put it into a column called emergency fund (yes, create this column). The amount you put here could vary based on your judgement about how contingent your life can be. If you want to stay conservative you should put about 40% or more of the remaining cash into this column.
- Finally allocate capital to cover your lifestyle expenses (yes, after all you deserve a movie or two with your family!). If you realize you don’t have enough money to meet all your lifestyle expenses, don’t fret. There are many cheaper ways to enjoy life too.
#3 Take Care Of Financial Loopholes
With less money to spend, it is in your best interest to check out for financial loopholes that drain your extra cash : A common example is Credit card debt. Your goal should be to pay those high interest debts as soon as you can. Use the emergency fund you created to pay for those expenses and cover those loopholes over time.
#4 Rinse & Repeat
With less liabilities and more money to spend, you are now in a position to increase the amount of savings you do every month. Again you don’t want to get into spending mode because you have extra cash. Always remember each of your dollar is capable of working hard for you to create many such soldiers over time.
That pretty much sums up how even a person with IQ of third grade, can become rich over time. No, I know you don’t have an IQ of a third grade, but when it comes to financial habits most people behave just like one. Path to financial freedom isn’t complicated, but if you are slave to your habits, it sure as hell not easy.
Understanding Parkinson’s law and its implications is important because it tells us a bit about ourselves. It tells us how we are conditioned to remain poor for rest of our lives. But it also tells us by artificially creating limitations on how much money we can spend, we can use the same law to our advantage and reap significant financial benefits.