Skip to main content

Calculating the True Cost of the Things You Buy

How much do the things you buy really cost? What’s the best way to quantify that? Most things have a price tag, but is it really dollars you are concerned about?

Vicki Robin and Joe Dominguez presented the concept of Life Energy in their book, Your Money or Your Life. With Life Energy, they show that there is a difference between what your “salary” is and the real earnings on your time. What you think you are making is reduced from one end by taxes and job-related expenses, like the cost of commuting, job specific clothes, or the things you buy to relieve stress from your job. On the other end, your effective hourly compensation is decreased by the time you waste getting ready for work, commuting, decompressing after work, taking vacations just to get away from work, and so on. Their website has a great calculator to help you get a feel for your real hourly wage.

Ultimately, their point is that you are trading your life energy, your limited time on this earth, for money. It is therefore important that you are intentional when you spend your money, as you are effectively spending your life.

We’ve all heard that time is money, and thinks to Vicki and Joe we may also understand that money is time. Additionally, the tools of Financial Independence give us a framework to evaluate spending in terms of your time, so you can properly evaluate whether the things you buy are worth the time they will cost you.

Spending comes in two main categories, one-time purchases and recurring spending. Most spending is actually recurring, with one-time purchases consisting largely of major lifetime events. For example, an engagement ring will (hopefully) be a once in a lifetime purchase. A car purchase, however, only seems like a one-time expense. In reality it comes saddled with many recurring expenses like gas, tires, brakes, oil changes, insurance, maintenance, and repairs before you eventually run through its useful lifetime and have to purchase another car.

One-time Purchases:

Let’s start with calculating a one-time purchase. You may know the price of what you are buying, but that price is in dollars. We want to convert those dollars to time. For a one-time purchase, this starts relatively straight forward. All we need to know is how much money you are saving and the purchase price.

For example, let’s say you are saving $20,000 per year towards your Target FI Number. If you are evaluating a $5,000 one-time purchase, then instead you would be $5,000 short and only be saving $15,000 this year. Since it otherwise takes you a year to save $20,000, then the amount of time $5,000 costs you is:

$${$5,000\over $20,000 / year} = {1 \over 4}\ year = 3\ months$$

Note that for a one-time purchase we don’t necessarily need to know anything about your Target FI number, your income, or expenses, only the ratio of the cost of the purchase to the amount you are saving. To generalized the equation:

$$Time\ Cost={Purchase\ Price \over Savings\ per\ Time}$$

Interestingly, the less money you are saving, the more time things cost. This is another example of a non-linear effect of savings. Someone who is not saving much, regardless of how much money they are actually making, takes much more of their life to purchase something.

Recurring Spending:

Recurring spending is more complicated to calculate and at the same time more detrimental to your financial situation. It not only slows your wealth accumulation but simultaneously increases your Target FI Number.

For example, let’s say you are evaluating whether you want to live with a $150 per month TV bill. That’s $1,800 per year$150/month * 12 months/year = $1,800/year that you will effectively add to your annual expenses. This has two effects: First, it will decrease your annual savings and therefore Stash Rate while you are earning. Second, since it is now included in your annual expenses, it raises your Target FI Number by 25Assuming a 4% withdrawal rate. * $1,800 = $45,000. Your target is higher and you are moving slower towards your target.

To put the two effects together, you would need to know your annual expenses and savings. Without yet taking into account the growth of your money or inflation, the time to reach FI in the base case would be:

$$Years\ to\ FI={Expenses \over Withdrawal\ Rate*Savings}$$

For example, with a 4% withdrawal rate, $40,000 of expenses, and $20,000 savings:

$$Years\ to\ FI = {$40,000 \over 4\%*$20,000}=50\ Years$$

To find the time with the added $1,800 per year cost, just add it to the Expenses and subtract from the Savings.

$$\text{Years to FI with Recurring Cost} = {Expenses+Cost \over Withdrawal\ Rate*(Savings-Cost)}$$ $$= {$40,000+$1,800 \over 4\%*($20,000-$1,800)}=57.4\ Years$$

In this case, the difference is 7.4 years just for the $150 per month TV bill. Fortunately, since we plan to invest our money, it will not be quite that bad. Adding in the effects of compounding growth to our wealth helps to narrow the gap as the money we are able to save generates returns that will effectively add to our savings. Both paths will be greatly accelerated and take much less than 50 years once the growth is taken into account.

These equations are more complicated and require some assumptions for growth and inflation, but you can experiment with different scenarios using the FI Calculator.

Plugging these numbers into the FI Calculator with some assumptions for growth and inflationIn this case, the investments growing 10% in the stock market with 2% inflation. show just this TV bill costing almost one and a half years of extra work; a great incentive to cut the cord! Notice if you plug in 0 for growth and inflation for both scenarios, you get the 7.4 years answer from above. Put your numbers in and let me know how much the things you are buying are really costing you. Any surprises? What can you cut back on to save years of life without feeling deprived?

Comments

Popular posts from this blog

Thrifty Thursday - Save Thousands on Your Phone Plan

Recurring expenses are insidious.  Companies love signing you up for subscription services as it means a consistent revenue stream by default.  The burden is on the consumer to take action, but momentum and inaction usually win out and the payments keep getting made. Taking a hard look at these subscriptions and other recurring payments can be very effective in reducing annual expenses, thereby lowering your Target FI Number and leaving more money for saving and investing .   Some expenses that don’t bring enough value can be eliminated.   Others can be greatly reduced with a little intentionality (just get a month or two of that streaming service to binge your favorite show, no need to leave it renewing for the whole year!)   However, there are some that are necessary but we can work on reducing their impact. One of my favorite hacks is switching to a low-cost cell phone plan offered by a Mobile Virtual Network Operator.    MVNOs lease bandwidth on existing cell towers ins

Stocks: How to Pay Someone Else to Work for You

 When you work for a company, you work to build someone else’s wealth.  When you own a company, other people work to build your wealth. Fortunately, you don’t have to be Bill Gates or Elon Musk to own a profitable company.   Instead, as we touched on briefly in the article on assets vs. liabilities , you can buy stock in the company.   Buying a share of stock mean you actually own a small piece of a company. One of the most efficient ways to own stocks is by purchasing low-cost index funds.   These funds can either be in the form of mutual funds or Exchange Traded Funds (ETFs).   The key difference to a traditional actively managed fund is that the index fund simply tracks the relevant market.   For example, an S&P 500 index fund would hold shares of the largest 500 U.S. companies In the S&P 500’s case, the largest 500 with some consistent caveats: at least 10% must be publicly available for trade

Calculating your Portfolio Target with the 4% Rule

You are saving money and learning about the difference between assets and liabilities . As you invest your savings into assets, the real magic begins. Your investments start to grow, whether it be from appreciation, cash flow, dividends, or all of the above. Then the growth starts to growth. Then the growth on the growth on the growth starts to grow. It’s a runaway chain reaction, but it does take time. This is the magic of compounding returns and leads to exponential growth of your wealth, the namesake of this blog. However, the opposite effect is just as powerful. Anyone who has ever been in credit card debt with interest rates over 20%, or even worse situations with payday or title loans, understands how hard you have to swim against the current just to stay still. The interest keeps racking up and many people never escape the debt. If this describes your situation, check out Dave Ramsey’s Total Money Makeover for steps to dig yourself out of debt before you start b