Sunday 25th September, 2005


Making wealth last

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There is a theory of household consumption, called the life-cycle theory of consumption, which says that households make decisions to buy goods, services, and create assets, based on projections of anticipated earnings over an entire lifetime.

In the early years of employment, individuals had a tendency to consume more than they earn. Borrowing is an important element in the financial plan during these years, and informal means of funding, such as borrowing from parents, the employer, as well as sou-sou are not uncommon.

This is also the time when hire purchase agreements are in demand, for essential household items such as appliances and furniture. In addition, any savings accumulated earlier on, tends to be used up in what is called dissavings.

The net worth of many such households tends to be in the negative arena. It is called negative wealth. This means that the total amount of assets owned by the household is less than the total amount of money owed to others. In fact, if they had to sell everything to pay off their debts, they would not be able to fill those obligations.

Some become helpless, pitiful and delinquent, unnecessarily so, because others pursue doggedly onward and upwards.

Then there comes a time when the children grow into teenagers and you think that will eat you out of house and home, but there is light of the end of the tunnel!

That’s about the time when breadwinners mature into their respective careers, and become the recipients of wage increases, bonuses, supervisory appointments and money-minded career offers, and the net result is more income.

The average propensity to consume becomes less in relation to the income earned. The household is already saturated with furniture and ornaments, the appliances have all been upgraded, and you have run out of closet space!

Yes, it is true that according to the Keynesian consumption theory consumption does increase with income, but not as much as the income increases, and the result is net savings.

Critical illness plan

A good indicator of wastage, at this point in the consumption cycle, is the closet space syndrome. If the household owns more clothes and more shoes than it has space to conveniently store, (does not include plastic storage bins and boxes) you have to cut back and convert such excess into dollars.

While this is a low-level measure, clothes and shoes are expensive, and you should calculate how much you would save if you didn’t shop for these items for two years. You may very well find that after two years, you can throw out the old clothes and get a brand new, more time-sensitive wardrobe.

Of course, this is also the time to dump lumpsums into your pension, re-evaluate your income protection policies (life insurance), and ensure that when your employer-sponsored health plan expires, you have a personal critical illness plan with concomitant and dedicated savings, at least up until age 75.

You should also acquire that second piece of real estate, get in on some stocks, and fine art, to experience the comfort of positive wealth.

Because the third stage in the life cycle theory is retirement, when income is cut, and you lose your health plan, you can only consume accumulated savings.

It is unlikely that people will still pay you to work for long, but you can make your money work for you in retirement!

If you are unable to do this, you consume your accumulated wealth. It would be thoroughly useful to understand how to ensure that your accumulated wealth outlasts your biological life cycle, without hampering your life style.

— Continued next Sunday.

©2004-2005 Trinidad Publishing Company Limited

Designed by: Randall Rajkumar-Maharaj · Updated daily by: Sheahan Farrell