We all know that there are different personality types out there when it comes to money. Some of us enjoy personal finance, others are bored to tears by it. Some of us are savers, others are spenders. For that latter group, there are even bigger risks than might meet the eye!
What I mean is that when it comes to making smart purchasing decisions than simply controlling expenses. Sure, we should make sure that income exceeds expenses, and that the more we save for retirement and old age, the better off we will be. But if we want to increase net worth, it’s important to think about how time and spending can be interrelated.
To illustrate this, let’s use an example of a hard working, responsible person out there. Let’s assume this person makes $75,000 per year and saves $15,000 after all expenses, including taxes. Saving 20% of gross income, not bad!
Let’s say she then wanted take a mini-vacation with friends, and spend $1,000. No big deal? Well, I think the impact of spending extra money might be greater than this person might realize.
Keeping in mind the income and savings of this person, let’s look at 3 things to consider before spending money.
The Time Value of Money
By this, let’s first consider the notion that a dollar today is worth more than a dollar tomorrow. Due to inflation, the purchasing power of a given amount of money will go down over time. Remember when a $1 could buy more than a gallon of gas? Maybe I’m getting old, but I distinctly recall paying 89 cents per gallon back in the 1990’s. I still remember the sign outside that gas station.
What would that 89 cents buy today? As of this writing, less than 25% of a gallon of gas. It’s not just gas that’s gone up, as we know. Food, education, clothing – you name it, it’s gone up in price. The cost of living increases over time.
Rather than spending the money, what if we saved it instead? We could actually keep pace with inflation, or if we invest well, actually see our money increase! Unquestionably, rate of return matters.
Back to the person we brought up earlier. If she saved that $100 instead of spending it, and invested it well, it could be worth more in the future. Let’s say she invests it and earns a rate of return that’s 4% more than inflation, after taxes. After 20 years, that $1,000 would be worth over $2,000 in today’s purchasing power.
Thus, spending $1,000 might really be like spending $2,000.
Hours Worked to Afford It
One of the things we can think about it is the hours worked to afford a purchase. We’ve talked about this before, and we can revisit the concept with this example.
We already said this woman earned $75,000 per year. If we assume a standard 2000 hours of work annually, that comes out to $37.50 per hour. Let’s say that after taxes, this comes out to $25.00 per hour. In this situation, that $1000 mini-vacation with friends ended up costing 40 hours of work. That’s one entire week at work, just for a vacation!
Hourly Savings Rate
Back to our friend and her vacation. If we go beyond how long she had to work for this, let’s consider that what she really had available to spend was her savings. Meaning, after all of her expenses, she had that $15,000 of savings we alluded to earlier. That $1000 mini-vacation ended up being 1/15 of year annual savings!
She would have to work almost 3.5 weeks to earn $1,000 in savings! Just imagine if she only saved $3,000 per year instead. That would be 4 months of work to save that $1,000 she wanted to spend on a vacation!
Bottom Line – when spending money on purely discretionary purchases, let’s keep in mind how hard we really have to work for it and what it can become if we invested it instead. That doesn’t mean we shouldn’t ever splurge of course, but it’s important to think of the real value of our money and our time.
My Questions for You
Do you ever think about these factors when making bigger or discretionary purchases?
Which of the three factors makes the biggest impression on you?