In debt? Where do you start cutting?

As I thought about these ideas further it occurred to me that not everyone will have the same preferences of what is important and what is relatively unimportant.  Some people would rather live in the now and enjoy the money they have by spending on consumer goods rather than pay money for something that may never be needed as in the case of healthcare.

  When I was in college I remember in Economics 101 studying Utility theory. The basic idea behind this theory was that each consumer received a certain level of satisfaction from the consumption of consumer goods. This satisfaction was measured in Utils. So for example a cup of coffee might be worth 50 Utils but for someone else the coffee might be worth 70 Utils. The concept of Utils is arbitrary and abstract. What value do you assign to a Util? And more importantly how do you measure Utils? The key thing is that it is a neat way of explaining differences between consumer preferences.

  How can you use Utility theory in your financial life to make a difference? You need to realize that some things are more important and life enhancing to you than others. At the same time the things that you prefer need to be balanced against the things that are necessary to have in your life. Take the example of healthcare – what satisfaction would you get from that versus say cable television? Yeah I know very little but now lets think about it a different way. Let’s say you had an accident and you were in hospital for a few days. How do you think your satisfaction level of the cable TV versus healthcare insurance might be affected? Seems obvious doesn’t it? You would want to have the best healthcare cover possible. 

Don’t worry I’m not some health industry crony. I’m just using this as a good example of the part preferences play in our spending habits. You can apply this logic to any two consumer choices. What brings you more satisfaction? A nice meal or a nice outfit?

Where Utility theory is most useful in your personal finances is when you begin to apply to choices between things like paying your credit card bill or having twenty lattes. If you are in debt it is crucial that you identify which choice means more to you. Does paying off your bills and the prospect of being debt free bring you more long term satisfaction than the short term hit of going for a weekend away? What I am saying is that you need to decide what is more important to you. Accruing more debt so you can continue to get the short term hits of satisfaction or the knowledge that one day you will be debt free and that you are building a secure future?

Prioritizing is the key.

How you prioritize your spending choices will depend a lot on your financial goals. You need to be clear about your financial goals before you can even begin to prioritize your spending. If your goal is to be debt free then you will prioritize your spending with that goal in mind. If your goal is to maintain your current spending habits then your will prioritize your spending based on that. You need to make the decision about your financial future and if you want to be debt free. Only then can you make changes to your spending habits. Until that point I’m afraid you are wasting your time.