“Can I afford it?”
This is the first, second and third question you should ask yourself before buying something.
How many of you smirked or tutted? Probably one or two, but I’m sure a lot of you said well yeah of course, that’s what we do too!
The way I like to decide between buying something and leaving it, boils down to such a simple question. However, this is a very loaded question. Can you afford to eat out for lunch every day? Probably. How much will it cost you over 10 years? How much will it cost you, had you saved and invested that same amount over 10 years instead?
Now we have the real question. What is the opportunity cost?
Opportunity cost is the value of a choice, relative to the alternative. When you buy something, there is always an opportunity cost. No matter what.
Even if you make the smartest choice (I am biased) and passively invest, you are missing out on potentially putting a down payment on a rental property that may give you back 10% returns down the line.
Or maybe there will be another housing crash and you dodged a bullet….
Hypothetical scenario #1:
I am in the market for a new car.
I always wanted a VW Golf and I happened to find one on a used car website. A Volkswagen Golf 2.0 GTI DSG 200BHP in perfect condition for €4,995.
I saw an ad for the new Volkswagen Golf GTI 2.0 TSi 245 BHP 5 door. It’s sporty, goes fast and I would look pretty good in it if I do say so myself. Aaaaand they even offer a way to finance it on the site as well as a calculator. Let’s take a look:
OK so my monthly salary after tax is roughly €3,500 so GREAT! I can afford to pay for this car right? WRONG, OH SO WRONG!!!
What the opportunity cost?
Option 1 = €4,995
Option 2 = €41,595 + €1,549.34 (interest and charges)
So the cost extra cost of getting option 2 is €38,149.34
However, don’t forget that could be money put into your savings instead. Assuming that we are putting savings into an investment account (an ETF that tracks the S&P 500 index), these savings would compound at an average of 7% per year over 10 years. So €38,149.34 at that put into these investments at a rate of €639.69/month for 3 years (same as car repayments) then it compounds to €66,265.09.
Therefore the REAL difference between these cars is €61,270.09……YIKES!
Even though the newer car would be amazing, the used car option is only 11 years old, in good condition and completely suits my needs. Having the newer car isn’t worth paying €61,270.09 ……… decision made very easy!
Hypothetical scenario # 2:
One of my personal vices is diet coke…. dear lord look how delicious that looks….
A lot of people have similar vices like coffee, tea, soft drinks (soda to the North Americans among us), energy drinks!
I am going to stick with my diet coke cause it’s my blog, my choice! Here in Dublin, a 500ml bottle of the fizzy black gold averages about €1.70 and I definitely get at least two per day. That’s €3.40/day or €1,241/year.
Now I enjoy my diet coke but 2 a day is unnecessary, so lets say I cut ot one. €1.70/day…big deal! Let’s have a look….
€1.40/day over 10 years = €5,110 compounded over 10 years at 7% = €7,283.38
Over 7 grand in 10 years just by having 1 less diet coke per day?? Makes me kinda want to give up the other one as well!!
Look at every purchase
There you have it, if you want to figure out if something is worth buying, plug in the numbers and see if it is really worth that to you. I can afford €1.40 a day, but do I want to give up €7,283.38 every 10 years for a quick fix? Not particularly, Future FIRE-ish will thank me for it!
Apply this to nights out, dinners, cinema, etc. and you would be surprised what you will be glad to cut out. I am not advocating giving up everything, only some things, so that you can reach financial independence sooner.