When thinking of the job of an economist, we might think of something like a math wizard in an ivory tower with a mega calculator and, possibly, a crystal ball. It’s true that economists need impeccable math skills, but many of the principles they swear by aren’t as complex as they may sound.
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In fact, you too can think like an economist — even if you’re terrible at math. And doing so can save you money.
Economists don’t just think about what the current purchasing power of a dollar is; they also think about what that power could become once you factor in future compounding.
“That is, don’t think about simply the consequences of a purchase today, but what you could be foregoing in future purchasing power,” said Robert Johnson, PhD, CFA, CAIA, chairman and CEO at Economic Index Associates.
“Let’s say you are thinking of buying a simple latte at Starbucks today for $5,” Johnson said. “Some economists (and investors) would look at what that $5 could turn into in the future. Assuming you could earn a 10% annual rate of return on invested capital (and since 1926 that is the average annual return on the S&P 500), in 30 years that $5 could become $87.25.”
Johnson added that Warren Buffett famously used the concept of opportunity cost when he asked, “Do I really want to spend $300,000 for this haircut?”
“He obviously never spent $300,000 on a haircut, but what he was referring to was how much that sum of money could grow to in the future,” Johnson said.
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When you spend, say, $20 using a credit card, you aren’t — unless you pay your balance in full and on time — actually spending $20. You’re spending that plus whatever annual percentage rate (APR) your credit imposes.
Economists always know their cards’ APRs for this very reason.
“Some credit options could offer lower interest rates but with a higher APR,” said Pablo Troncoso, instructional assistant professor in economics at the University of Houston. “Remember, APR includes interest rates and additional fees. It is the number you can use to compare apples with apples among different options.”
Some financial experts recommend autopay for your routine bills — but economists tend to think otherwise.
“You might continue paying for services you no longer need,” Troncoso said. “Companies offer discounted prices when using this option, but this decision could result in additional payments that are not needed.”
Hung up on sunk costs (the costs associated with an investment that cannot be recovered)? Let it go.
“New additional benefits and costs are what matter,” Troncoso said. “If an investment or plan requires an initial investment, it should not be relevant when deciding to continue investing. Forgone is forgone.”
Like pretty much all financial experts, economists generally recommend distinguishing between needs versus wants and really asking yourself, before pulling the trigger on a purchase (particularly one driven by impulse), whether the purchase is essential.
“Sales and discounted prices attract the attention of everyone, even people who would not buy the item under normal circumstances,” Troncoso said. “It does not matter that lawnmowers are 90% off if you live in a second-floor apartment.”
Economists tend to think one step ahead in regard to inflation and interest rates. You should do the same, and keep your eye on them regularly. This will help you make the best buying decisions — particularly if you’re taking out a loan to cover the costs.
“Inflation seems to be leaving, and interest rates should go down soon,” Troncoso said. “If you are considering buying a car or home, it seems to be a perfect time. Check the rates and remember that even a small reduction in the interest through a downpayment can save you a lot of money over time.”
Passive income is a great option if you have savings: Passive income usually requires less attention than traditional income. Rental property and dividends from stocks are some examples.
Finally, to think like an economist and save money, you need to dial down the feelings — at least when it comes to managing your investments.
“Do not let emotion and finance meet,” said Matt Willer, a private asset investments expert and managing director, Capital Markets, partner at Phoenix Capital Group Holdings, LLC. “They should remain independent of one another.”