Do you need to be frugal with your money?

My friend loves to cook. She spends a good amount of time everyday turning out delightful meals for her family and friends. When I met her last week, she told me how her mixer of 35 years is still functional. Very unsatisfactorily one would think, watching her use it. Her regret was that spares are no longer available as the manufacturer has long shut down. Why is she unwilling to see that the market for kitchen appliances has long gotten so advanced, that she can replace hers with something new? But it is still working, she insisted. Wouldn’t your life be easier with a more efficient gadget? Maybe, but this would do, she said.

In personal finance terms I would look at this as one that treats an item as capital expenditure and not revenue expense. A capital expenditure is large, not incurred routinely, and spent on an item intended to be used over several years. A business would depreciate a capital asset in order to expense a portion of it every year. A household would not explicitly do it, for it does not run with a profit motive. However, wealth maximisation is a household financial objective. Money saved and not spent, contributes to that objective. It does make sense to be careful about expenses. My friend told me that her daughter in law would not bat an eyelid before replacing the old mixer. Why grudge that, I asked. She did not know the answer. Our story lies in this shift in mindset between capital and revenue that has happened across households. It might not be a cause for concern as enthusiastic nostalgic people would have us believe.

There was a time, say 35 years ago, when my friend bought her mixer, when household incomes were insufficient. A middle class household pulled through the last few days of the month with palpable stress, awaiting pay day. Any large expense needed sacrifice and patience. Banks never made retail loans then. Employees took advances from employers or bought goods from retailers that offered an installment payment facility. It made sense to be frugal with every head of expense then. And capital expenses had to be expenses over as many years as possible to keep the burden low. Times have changed indeed. It is not uncommon for middle class households to find adequate balance in the savings bank account before the next pay day. Incomes have moved up for a large section of the population. Capital expenses are not difficult to make as loans are easily available to acquire anything that won’t fit a normal monthly salary. Repayment in EMIs is understood as an easy way to expense that large spend.

So much so, that households do not bother much with the math of the loan, or the effective rates of interest, as long as the EMI comfortably fits within the monthly income and leaves enough buffer for other expenses and savings. Banks and finance companies are eager lenders to the retail market, competing for business, eagerly maximising how much EMI a given income can bear.

Markets for capital assets have changed dramatically too. The most significant being the housing market, perhaps the most sought after capital asset for a middle class household. That equation is a true capital expenditure decision for a household— the value of the asset, its residual value after paying off the loan, and the years over which that would be leveraged, are all valid questions to ask and answer. But almost all else has ceased to be a capital expenditure. The cost of many consumable goods has fallen due to abundant supply and better technology and efficiency. The cost as a percentage of the median household income has dropped, both from rising incomes and lower costs.

Therefore, everything from cars to cell phones, holidays to household appliances, clothes to eating out are all routine revenue expenditures for a household. If a car loan is paid off in three years, it is more often the case that the borrower takes a fresh loan to upgrade to another new car with a fresh loan. This is because the borrower mentally sees the EMI as an expense and is not treating the older car as a capital expenditure that must be utilised until the car is grounded. The tangible and intangible benefits from driving a newer car, and the ability and willingness to expense that amount have modified consumer behaviour significantly. It might not be worthwhile to struggle with an old mixer or feel proud of that frugality.An entire ecosystem of producers, lenders, service providers, tax collecting governments, benefit from this changed mindset. We may be tempted to swipe off this tendency as consumerism and begin to list the ills. We could also benefit from seeing the socio economic preferences that develop with plenty and prosperity. The world might be a better place for this change in mindset, if we also solved for wastages, trash, recycling and such social costs of this behaviour. But I wanted to make another point while we are at it. Tremendous damage to our ecosystems has been inflicted from a scarcity mindset that characterised the limited income, scarce resources, shortage and rationing systems that existed many years ago. Punishing frugality and settling for compromises in quality, efficiency, and speed were part of the mindset that presumed one must make do. An earlier generation might be stuck in this narrative. We may be shifting as an economy towards a generosity mindset that believes there is enough for everyone. We may be confident about finding a job, earning an adequate income, spending it to make our everyday lives comfortable, and being fearless while evaluating alternate uses for our money. A younger generation might be indulging in this narrative.Both segments might have probably gone too far in their pursuit of their favourite narrative. The young might find the old to be too stingy and needlessly tight-fisted; the old might find the young to be reckless in spending and vain in their pursuits. But there is no telling where the middle lies as the pendulum keeps swinging as long as the clock ticks. These are but alternate assumptions about how much money is needed, how long it would last, and how much must be kept aside and how much is to be prudently spent. We don’t have any definitive answers to any of those questions. We mostly won’t either.

(The author is CHAIRPERSON, CENTRE FOR INVESTMENT EDUCATION AND LEARNING.)

(Your legal guide on estate planning, inheritance, will and more.)

Download The Economic Times News App to get Daily Market Updates & Live Business News.