Over-investing in finance

Finance

"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...

, particularly personal finance

Personal finance

Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget, save, and spend monetary resources over time, taking into account various financial risks and future...

, refers to the practice of investing

Investment

Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...

 more into an asset

Asset

In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...

 than what that asset is worth on the open market. It is cited most frequently in reference to expensive personal consumable investments such as houses, automobiles, and trailers.

Example

If a homeowner makes additions or improvements to her house to the point that the owner has invested considerably more than the market value of other houses in that area, then she has likely over-invested in that house. The "neighbourhood effect

Neighbourhood effect

The neighbourhood effect is one of the contextual variables that explains the tendency of a person to vote in a certain direction based upon the relational effects of the people living in the neighbourhood. The voting preference of a neighbourhood tends to be formed by consensus, where people tend...

" will serve to devalue the house so that it is worth less than what has been invested in it. Another example is a person who buys a used car for $2000, spends another $2000 on repairs, even though the 10 year old car will never be worth more than $3000 on the open market; they may have over-invested in the car by $1000.

Avoiding

Over-investing typically occurs in assets that are partly investment goods and partially consumption goods. Houses and cars are investment goods in the sense that the purchaser expects to be able to resell the asset in the future. They are also consumption goods in the sense that the owner is able to use the asset while he owns it. It is because of this consumption component that people tend to over-invest. They are using criteria other than purely financial ones when deciding how much to invest into the asset. They are prepared to spend more on a house or car than it is worth on the open market because they derive benefits from using them. Because of the confusion between consuming and investing, they may over-invest or under-invest compared to what they would do if the investment were clear. Another major problem is that people spend more on consumption value (such as home rent) because they own the asset and mistakenly think that they are investing, when really they are consuming a house bigger than the one they would normally rent. Although they gain something from consuming more, since it is more than they would normally consume, they are wasting some money on something they would not normally buy, and thus in a sense over-investing by over-consuming.

The confusion between the consumption value and the investment value can cause people to under-invest or over-invest in the asset. The investment value comes from the floating price of similar assets on the open market. Consumable values are things such as rental value, pride of ownership, and personal affect. One method that can be used to avoid over-investment is to calculate the consumable value separately from the investment value. The family that lives in the house they own, for instance, can keep books of their investment, renting the house to themselves. That allows them to compare the investment value directly with other investments, and their consumer value with other homes they could rent. They may gain a little on the investment side by having themselves as tenants, and they may gain a little on the consumer side by having themselves as landlord's. This method makes it much easier to compare with other opportunities.