When making everyday purchasing decisions, we have variety of ways that we determine whether or not something is a deal. Maybe it’s at a low price compared to the price we’ve seen it elsewhere. Perhaps, it’s priced well compared to substitutes. For some of us, we consider how a purchase fits into our budget.
What about thinking about how a purchase impacts our long-term financial situation?
On the surface, this makes sense. The more we spend now, the less we might have in savings later.
For example, let’s say you’re deciding between 2 vacations for the summer:
- An inexpensive, 4-day vacation that’s within a few hours from home, with fun activities and solid if unspectacular lodging. Cost: $1,000
- A pricier, 7-day vacation that requires booking a flight across the country, also with fun activities, but more upscale lodging. Cost: $3,000.
If these are your two alternatives, you have a decision that involves an incremental $2,000 at play. So, by choosing option #2, it can be said that you’re taking $2,000 away from your future retirement. That is, assuming of course that you would saved it instead of splurging on something else. That’s an assumption to be sure, but let’s go with for now.
Down the line, you’ll have to earn an extra $2,000 to make up for that amount, right?
I think that might be true, but in reality it could potentially be a lot more than that. As I postulated in a post last year (when Squirrelers was fairly new), what you spend today could mean something very different in the future. Your opportunity cost is not just what you spend today, but what that money might become in the future.
Let’s take that $2,000 from the example above. What would that be worth in the future?
Well, let’s assume it’s invested and grows at 5% per year. Let’s say this is after taking inflation into account. That $2,000 will be worth the following amounts, at different points in time:
Clearly, that $2,000 which was spent turned out to be just like spending a lot more future dollars. Factoring in growth, that vacation actually cost $8,644!
Crank up that growth rate to 8%, and this $2,000 becomes something much more:
$20,125 after 30 years. That sure was an expensive choice, to upgrade to a deluxe vacation!
Now, the purpose of this exercise is obviously not to focus about different expected rates of return, or the merits of spending on vacations. Rather, the takeaway is that when we spend money today, we’re really spending a sum of money that might be worth a lot more in the future.
From big purchases all the way down to the smallest purchases, I think this concept holds.
My Question for You:
Do you think about how a sum of money today can be worth a lot more in the future, and connect it to spending decisions made today?
I will occasionally think about such things but must admit that it isn’t very often. I have a designated amount that is for retirement savings. Beyond that, I don’t worry too much about playing a round a golf or going on vacation because you never know when you could die in an accident. The basics are taken care of so I am going to enjoy myself a little.
cashflowmantra – yes, it’s a balance to be sure. We don’t know about the future, you’re right, so there’s nothing wrong with living in the moment with money sometimes.
That’s an interesting way to view things that definitely makes you think; typically I don’t do it though because I all ready have such a tough time spending money! The guilt:).
Amanda – yeah, I know how that guilt can go. I think of opportunity costs in that way.
I absolutely think about future cost! I think every investor should be aware of the power of compounding.
Not to say one shouldn’t have a decent vacation, but be aware of what ‘extras’ actually cost. You convey this message very nicely in this post Squirrelers!
Moneycone – thanks for the feedback! Yep, compounding has power, no doubt. It’s just forgotten much of the time 🙂
I don’t think like this very often. Clearly I need to do so more often. 🙂 I am on vacation now and trying to moderate costs by bringing some food from home. We just had chili from home tonight instead of going out.
Melissa – I think most people don’t think like this, which is why I put this post there. It’s interesting, though, how we can view our expenses in a somewhat different light when considering the future. Good move bringing food from home – that cuts vacation costs!
A lot of people are present-oriented rather than future-oriented. That’s why they don’t think of the impact that their purchases today have on their wealth later.
MBH – yep, that’s the deal!
Good point here “the takeaway is that when we spend money today, we’re really spending a sum of money that might be worth a lot more in the future.” I totally agree and also that is what you called savings and investing. Great post Squirrelers ! 🙂
Shannon – thanks, glad you liked the post! Saving and investing, that’s the name of the game to grow our money. Spend now, you could be spending something that will be worth much more if invested well.
I do think about how spending large chunks of money will affect me, but not quite as far in the future as you’ve worked out. I like to see the “big picture” and this definitely solidifies the fact that I need to think longer term.
Little House – yes, it’s sometimes tough to see past our immediate needs. Tomorrow seems like a secondary priority, though we need to work for tomorrow’s needs today.
We’re actually having this debate around a vacation right now in our house. Our original plan was to do a cross-country trip but the cost will be around $1,200 per person. With my first tuition bill coming due this month and being so close to my goal of paying for my MBA in cash, I’m developing cold feet (nothing is purchased yet) and I’m pushing for a more local vacation that might cost 75% less. It’s a harder discussion than you’d think sometimes. Ah well, it’s good to have the luxury of a $2,500 or $500 vacation being our big problem at the moment.
No Debt MBA – sometimes we do have to live in the moment and take advantage of great experiences. I actually did just that while still carrying MBA loans. Crazy? Maybe, to most. Actually, was counter to what I’d normally recommend and try to do – so it seemed crazy to me too. However, it was more than worth it and generated life experiences I won’t forget.
A common debate in my household. Wifey dear wins when it comes to jewelry and I win when it comes to tech stuff. So challenge is to save enough for the future and still enjoy the moment. I do not see any fun in my wife wearing jewelry when she is in her 70’s or 80’s .
However yes I am worried that it is becoming more and more expensive to live post retirement, so you post will help keep that in mind.
John – the way I look at it, we’re working for today and tomorrow. So sure, enjoying the moment is great, I’m all for that. It’s a matter of balancing priorities and discerning wants from needs. Easier said than done!
while you make an excellent point, i think it’s sometimes acceptable to take that $2k for now because you never know what can happen in the future.
Jana – while I advocate saving for the future, it’s true that we never know what could happen. That could go both ways, encouraging spending now or saving for unforseen circumstances.
As I get older, I’m caring a lot more about time vs money, so I do a similar thing to you but instead of thinking about the money that may end up being in the future, I think about the time it took to earn it. I also theoretically tell myself that if I don’t spend that money that took a week to earn, then I’ll have to work 1 less week at the tail end of my career.
First Gen – I totally think in terms of time it takes to earn money as well. Makes blogging seem like a low ROI endeavor, though there’s the enjoyment and mission that’s a part of this as well:)
I completely agree with mbhunter- it’s all too easy to be present-focussed, ignoring the future and failing to make plans for it. It’s much easier to justify spending decisions in the present, without bearing the guilt about the forgone future opportunity.
I am about to hit forty in a year and believe only last night I realized how minimal I have saved till now. This article will definitely help me achieve my financial goals and hopefully curb my spending.