"Practical Wealth V. Phantom Wealth" covered how to measure your financial wealth accurately by accounting for liquidity and stickiness (resistance to change). This article now covers how people reduce their liquidity without realizing it.
Consumerism Alchemy: Turning Assets into Consumption
Most people realize that some assets such as cars depreciate and the depreciation supposedly represents the consumption or usage of the asset in wear-and-tear. However, many people then assume that any retained or core value at any point in time is a positive asset (often for their supposed "net worth")--but people often behave in ways that turns an asset into additional ongoing consumption.
2 ways in which "retained" asset-value becomes consumption:
- The Resale Value Trap: Resale value is an "entry fee" surcharge and should be kept as low as possible. Resale value is a marketing trick to encourage overbuying. Never trading down (liquidating an expensive asset and buying a cheaper one) means that any core value is consumption, an expenditure never to be recouped. Some people fool themselves into thinking that they pay for car depreciation but “keep” the resale value, which is untrue, practically speaking. If you continually trade-in cars when they reach $10k value, that $10k (plus any interest) is forever lost as permanent consumption, an "entry fee" for "getting in the game."
- The Emotional Attachment Trap: Emotional attachment is a form of illiquid stickiness that turns an asset into ongoing consumption. Count your car only if you are willing to trade it for a junker. Otherwise, it is phantom wealth because you would never tap it. Instead of disaggregating the value of basic transportation from surplus conveniences (CD player, etc.), you are treating the whole, indivisible car as psychic consumption. Do not count your grandmother's wedding ring if you would never sell it despite defaulting on your mortgage.
Next: Best-Worst Financial Measures: How To Track Your Financial Independence and Security
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