FUNDAMENTALS OF FINANCE
A Guide for Helping Professionals
Adam J. McKee
SECTION 5.3: The Importance of Value
The word value can cause some confusion; it’s a vague word. Sometimes we use it to mean the cash price we’d expect to pay for it. As I am using the word in this book, that definition goes too far. The reason I say this is because I see plenty of examples of things selling for far more than they are actually worth. A lot of times we pay for brand names, we pay for convenience and other intangible things that aren’t worth the money we’re shelling out. Sometimes we use the word to mean “cheap.” That is another bad use of the word. Cheap products that are shoddy and will not last hold no real value. Perhaps it is best to automatically add the word “real” before the word “value” anytime you encounter it in this book.
When I first started in law enforcement, I was a reserve deputy and had to buy all of my own equipment. My first pair of duty boots were the cheapest I could find (after the sidearm, I was pretty broke!). If I recall correctly, I paid around $50 for those boots. They were inexpensive, and I thought I’d found a great value. After my first 12 hour shift in those boots, I realized that they were worth less than zero. I had bleeding blisters on my feet and no arch support. Because I bought cheap boots with no value, I threw my money away. My next pair of boots costs around $100, and I still have them stuck in a closet somewhere. The moral of this story is that getting something for a good price is throwing your money away if it has no value.
The flip side of this story is when you pay for a name, or a style, or any other thing that is fleeting and the real, underlying quality (a major component of value) is not there. My kids loved a particular type of shoe that was endorsed by a famous athlete. The shoes were incredibly expensive for shoes, and they were poorly made. The shoes quickly fell apart, and the only value anyone got was my money that the shoe company and the athlete got. The moral of this story is that paying for fleeting intangibles is a colossal waste of money. Celebrity endorsements and the coolness of being in style are of questionable value, especially in the long term.
Big ticket items can have value components as well, and you should be aware of these. When a person buys a new car, an often cited reason is that the old one is no longer “dependable.” We assume that a new car will be very dependable. What often motivates the purchase of a new vehicle is the cool factor, and the allure of that “new car smell.” I may get my legs broke by a couple of guys from Detroit, but buying a new car is almost never a good idea financially. Vehicles of all types lose a substantial amount of value when they drive off the showroom floor. Even if you only owned it a month and drove it less than 1000 miles, it is still now a used car and worth far less than it was new. The shopper looking for value that purchases this “used” car is only too happy to let you pay for the first $6,000 of his almost new car; it even still has that new car smell!
The trick, then, is to look for real, tangible value when considering a purchase. Many people fail to do this important task, even when the stakes are incredibly high. It is crazy to make decisions on which car to buy or which house you buy based on emotional conjecture and feelings. When we have positive feelings about something, we tend to find the good and minimize the bad. Read up on “staging” in real estate! Crafty agents staging a house will actually bake cookies because the smell of baking cookies will influence the purchase decision.
It impacts us on a visceral, subconscious level. People trying to sell you something are always trying to play you; no real estate agent has your best interest at heart if you are the buyer. No used car salesman is really your buddy. They are in business to make money, and you are the customer. That is the sales job; don’t be angry at them for doing their job. Just know they are trying to “play you” and make your decisions by the numbers. You will almost never make bad decisions when you are buying value. Things get much trickier when there is a perception of value; sometimes this can be to your advantage (such when the market overpriced a stock that you own), but most of the time value that is merely perceived only benefits the seller.
Most of us aren’t capable of determining the real value of something; we don’t have enough information to make a wise choice. With houses, we can hire a professional appraiser that can tell us an objective estimation of a property’s value. With cars, we can use services like Kelly Blue Book to find a pretty fair estimation of value. With consumer goods we can comparison shop (the internet has made this really, really easy!) Just keep in mind that what you really want is a good deal. A good deal on a car means that you beat the blue book value by a good margin. A good deal on a house means that you got it under the appraised value. When the underlying quality is there, getting a discount does add value. That is a big part of our wealth building strategy; we are always looking out for value at a great price. With everything from a hamburger to a company’s stock to a new house, we want excellent quality at a great price.
Always remember that value is to a large degree a matter of perception. Some things can change in value in the blink of an eye, and some things are timeless (or nearly so). The very idea of something being “trendy” says that the value is present only because of a fleeting consensus. It will change quickly, and you will have lost the inherent value in the trendiness. Another aspect of this phenomenon is paying for a perceived value (trendiness, luxury, etc.) when you never stand a chance of getting your money back. Redoing your bathroom in the “timeless look” of marble may be expensive, but can make sense because it adds value to your home. That is, if it is a calculated investment in your home, then it can be a good idea. Drinking $1000 champagne, on the other hand, is just stupid unless you have so much money that you just don’t care about losing $1000. If you are still working for a living, you should avoid things that have adjectives like deluxe, premium, luxury, well appointed, and so forth in the name.
Everyone wants “nice things.” The problem with wanting nice things is that if everything you buy is “nice”, then you are probably spending too much money. There is a very old saying that “a penny saved is a penny earned.” That may be a platitude, but a penny not wasted is a penny that you can put toward value. For many things in life, “It’ll do” should be good enough.
The Elements of Value
When potential customers evaluate a product (or a service), they consider their perception of its value compared to its price. This sounds like a simple “cost-benefit analysis,” but since the computations are being made by people instead of computers, it is highly complex. The following are things that you should consider carefully and rationally before you “pull the trigger” and buy a product.
In a Harvard Business Review article entitled “The Elements of Value,” Eric Almquist, John Senior, and Nicolas Bloch identified 30 “elements of value” that are the fundamental building blocks of consumer conceptions of value. They divide these elements into four basic categories. These authors aimed their work at businesses trying to improve their bottom line, but we can use them to inform us about how we form perceptions of value and perhaps develop strategies of how to make better spending decisions. The four categories these authors identified are: Functional, Emotional, Life Changing, and Social Impact. The authors suggest that these “needs” are hierarchical, reminiscent of Maslow’s Hierarchy of Needs.
Functionality. For something to have true value, it must do what it is supposed to do and do it well. With some purchases, especially expensive ones like houses and cars, the idea of functionality is a multifaceted concept.
Emotional. How a product or service makes the user feel.
Life changing. How a product or service changes the customer’s life.
Social impact. How a product or service delivers value to society.
In addition, the Elements of Value can be categorized based on whether they provide inwardly focused value, such as reducing anxiety, or outwardly focused value, like conveying a sense of affiliation and belonging.
You versus the Business World
The Elements of Value articles also explains that businesses that tap into value make extraordinary profits. High-performing companies hunt for value relentlessly. They leverage the Elements of Value in two ways:
- Improve performance. High performers strive to deliver more value on elements that drive Net Promoter Scores in their category. They identify and capitalize on their relative strengths to widen leads within their category on elements that matter. They go head to head with the market leader on core Elements of Value and close the gaps.
- Change the game. Companies can change the game by adding new Elements of Value to their category. It is helpful to identify the “white space” in the category where companies may be able to drive value and set themselves apart from competing companies. For value innovators like Amazon, the hunt for value is a never-ending process. Amazon Prime and Echo are examples of innovating new elements of value.
Take a minute to consider what that means for you as a consumer. If those companies are becoming more and more wealthy, than they are doing it with your money, so you are getting poorer and poorer. The key here is not to allow businesses to define value for you, but to determine the nature of authentic value for yourself.
Let’s examine the difference between purely online companies and “Omnichannel” (brick and mortar stores with an online presence) companies per the Elements of Value. Online-only retailers tend to win with customers on functional elements, while Omni channel websites win on emotional elements. Consumers appreciate that online-only retailers help them save time, avoid hassles, reduce costs, provide access, reduce effort, and simplify their lives. Omnichannel websites are seen as providing badge value, attractiveness, sensory appeal, wellness, self-transcendence, and affiliation and belonging.
Emotion is the Enemy
When it comes to the search for authentic value, our emotions are often our enemy. That is not to say that we can ignore our emotional wellbeing for the sake of thrift. The ultimate goals of our lives are self-actualization and happiness. What many of us fail to realize is that our long-term happiness tends to be very different from our near-term hedonistic tendencies. What feels good at the moment is often not in our long-term best interest. When it comes to spending your money on products and services, you need to think about it in terms of long-term happiness and consider the bigger picture. Of course, we must also consider our spiritual, moral, and ethical lens when making financial decisions.
Nobel Prize-winning economist John Harsanyi said that “apart from economic payoffs, social status seems to be the most important incentive and motivating force of social behavior.” There are serious, real-world problems that arise from our deep-seated need to have status. There is a growing body of literature demonstrating that individuals from low-status groups (e.g. ethnic minorities) tend to engage in more vigilant psychological self-protection than those from high-status groups. Low-status people are much more sensitive to being socially rejected and are more inclined to monitor their environment for threats. Because of this vigilance toward protecting their sense of self-worth, low-status individuals are quicker to respond violently to personal threats and insults. This in itself suggests that status isn’t merely an aspirational issue; it is something that some of us are literally willing to kill for.
To make matters worse, people tend to do the exact opposite of what they need to do to improve their status. The research literature on improving status was reviewed in an article by psychologists Cameron Anderson and Gavin J Kilduff. A major theme that emerged from their review was that those people who are effective in attaining status do so through behaving generously and helpfully to enhance their value to their group. In other words, low-status individuals’ aggressive and violent behavior is the polar opposite of what they should be doing to ascend the societal hierarchy. America is a land of opportunity, but if you grew up poor you don’t have the tools to take advantage of those opportunities.
This idea is implicit in the very notion of Socioeconomic Status (SES). The nouveau riche have always been looked down upon by “old money” precisely because they still exhibit the behavioral characteristics of the low-SES ranks from which they rose.
Research has shown that generosity is the key to status. People afford greater status to those who donate more of their own money to a communal fund and those who sacrifice their individual interests for the public good. Demonstrating your value to a group—whether through competence or selflessness—appears to improve status. Anderson and Aiwa Shirako suggest that the amplifier for this effect is the degree to which one has social connections with others.
Social ascension by proving valuable to social groups is not a pure meritocracy. It may well be based more on perceptual heuristics than anything else. Anderson and Kilduff demonstrated in one study that people in a group math problem-solving task who merely signaled their competence through being more vocal attained higher status and were able to do so regardless of their actual competence on the task. The “squeaky wheel gets the grease” is an old colloquialism that holds much truth, despite our social distaste for “whiners.” It seems that “tooting your own horn” is an important path to success, but only if it is not obvious that’s what you are doing. People in American culture do not like others who are open about their status-craving.
The idea of status is important for us in the financial context for two reasons. The first is that high-status professions and people tend to earn more money, and earnings are the engine of wealth building over time. A promotion at work, for example, is the conferral of a higher status, and more money comes along with that. The other major concern is the desire to achieve status from the possession of status symbols or by exhibiting behaviors that are associated with wealth and status within one’s culture. To a great extent, what we choose to spend our money on is motivated by the desire to appeal to our social environment. Status-seeking consumption, as well as compliance with social norms, are manifestations of such a motivation.
There is no utility in buying $1,000,000 houses, $100,000 cars, and $10,000 wristwatches, so it is more logical to assume that we want those things because they might indicate the superior social status of their owner. Ironically, those with high status often do not feel the need to buy those things; I suggest that this is because they had rather grow their wealth than waste it trying to prove to others that they are wealthy. It seems that ostentatious displays of wealth are usually among the newly wealthy that still have a mindset of poverty and those that inherited their money and thus have no sense of pride in its accumulation nor any appreciation for its value. Self-made Titans of Finance tend to live a frugal lifestyle. Sam Walton and Warren Buffet never owned a Bugatti, but we all know of their status. If Mr. Buffett decides that he wants a Ferrari, he will more likely buy the company than the car. (But only if he can get it at a great price).
The bottom line is that your status at work does matter. If you are regarded as an extremely competent team player and a decent human being, you will rise in the ranks and be rewarded with more promotions, more responsibility, and higher pay. In most professions, excellence is rewarded as is a dedication to the team. In your personal life, money spent on status seeking is financial folly. The drive to seek status is a strong one that is hardwired into our brains. You must force your rational brain to overcome your base self and conquer those primitive urges to spend on things that hold no authentic value.
The Time Value of Money
Investors clearly understand that money has time value. I most likely will not loan you $200 that you agree to pay me back in ten years with no interest. I’d much rather have my $200 today than ten years from now when it is worth a lot less (always remember inflation). Not only do you have to pay me enough interest to beat inflation so I don’t lose money, but you also have to pay me for the time value of the money—the potential rewards that I didn’t get to enjoy from it.
References and Further Reading
Almquist, E. (2016). Elements of Value: Measuring What Consumers Really Want. Harvard Business Review.
Waytz, A. (2009). The Psychology of Social Status: How the pursuit of status can lead to aggressive and self-defeating behavior. Scientific American.