How Much Is Just Enough? A Smart Spending Strategy

This week MoneyWatch editor-in-chief Eric Schurenberg produced an excellent video clip titled Risk vs. Reward which advocates that you don't set your financial targets so high that you need to make risky investment decisions to meet your lofty goals. He ends the clip with a story about a famous author who had a significant advantage over a much richer hedge fund manager: The author had "enough" money.

Let's dig deeper into the concept of "enough" money. Economists use "utility theory" to measure your satisfaction or happiness with an item that you buy against the amount of money you spend on the item. As the theory goes, if you have a significant, unmet need and you buy something that meets your basic needs, your happiness improves. But if you spend much more money to go upscale and buy beyond your basic needs, your happiness doesn't typically improve by the same amount.

We can see this concept by examining survey data regarding a purchase we're all familiar with: buying a car. J.D. Powers and Associates measures the customer satisfaction with various automobiles. Here's a chart showing the rated satisfaction with two Toyota models and two Lexus models (taken before the latest controversy with Toyota). To come up with a single number for each, I averaged the ratings on initial quality, performance and design, and reliability.

Customer Satisfaction

Note that as you spend more money, you indeed get higher customer satisfaction. But as you can see from the chart below of the costs of each car, you pay a very high price for modest improvements in satisfaction.

The Toyota/Lexus analysis shows the price/satisfaction relationship predicted by utility theory. Interestingly, there are even some car manufacturers where the more you spend for one of their cars, the lower the rated customer satisfaction.

This leads me to a strategy I use for all my purchases, whether for large items such as my house, cars, furniture, or appliances, or for smaller everyday items such as food and clothing. I buy "just enough" to meet my basic needs and what truly makes me happy. I don't listen to the ads which tell me to buy my way to happiness. Given the above results, "buying your way to happiness" should be called "futility theory!"

My previous post Can't Retire Yet? Don't Despair documents the meager retirement resources of older working Americans. As a result, we'll need to make every dollar count, before and during retirement. "Just enough" will be different for each person. Neveretheless, it's a smart spending strategy we all can use to make the most with our financial resources, and manage The Magic Formula for Retirement Security.

What's "just enough" for you?