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Thursday, December 17, 2009

Why the government is ALWAYS less efficient than the private sector.

Budgeting is probably the least favorite topic advisors have to deal with. How to spend money can be a very touchy topic. One way to start the conversation is with a simple but insightful analysis first put forward by Milton Friedman, winner of the 1976 Nobel Prize in Economics.

In his book Free to Choose, Friedman listed four ways to spend money: 1) spending your own money on yourself; 2) spending your own money on someone else; 3) spending someone else’s money on yourself; 4) spending someone else’s money on someone else.

In Case 1, spending your own money on yourself, you have the strongest incentive to economize and to get the highest value. When ordering dinner in a restaurant, only you can really decide if the extra cost of a higher priced meal is really worth it. Only a client can make the call as to whether he or she would rather spend $30,000 on a new car or spend $20,000 on a used car and put $10,000 away for the future.

Case 2, spending your own money on somebody else, is what most of us are doing right now during the holiday season. We have the same incentive to economize but not the same knowledge of what recipients would do with the money if they were spending it on themselves.

Buying lunch on an expense account is a classic example of Case 3, spending someone else’s money on yourself. You have a strong incentive to get your money’s worth but not to economize.

Finally, spending someone else’s money on someone else, Case 4, has the weakest incentives to economize or get the best value. This, unfortunately, probably explains why many government programs are not very efficient.

The point this simple analysis should bring home to clients is that they should weigh each dollar they spend. That is what Nobel prizewinners expect them to do.

[Stolen from FOUR WAYS TO SPEND MONEY, from Stephen J. Huxley, Ph.D., chief investment strategist, Asset Dedication ]

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