In Devolving the Myth of Income – Part I we discussed the case of Docsd (or just ‘Doc’) who said:
I have been awaiting approval on … an older historic horse farm on several acres … my goal has always been to live as far below my means as possible while accumulating wealth.
This generated some debate, which eventually boiled down to the following well known saying:
Never invest in anything that eats or needs repairing.
Attributed to Billy Rose, the famous Broadway producer and investor.
But, you can’t always just distill your life down to the pursuit and saving of money – there is a word for being too frugal: it’s called being a miser! Sometimes, you have to make a lifestyle decision …
For example, buying a house to live in may not be the best financial decision in the strictest sense (but, still a sensible financial decision for most people) yet we often buy them for the emotional values: sense of ownership, stability, a house is a home, my wife will divorce me if we don’t 🙂 and so on.
Put simply: there are many acquisitions that we want to make in life that are lifestyle acquisitions not investment acquisitions.
And, the real financial question associated with them is: I really want it but can I afford it?
Unfortunately, there are no hard and fast rules on these things … so I came up with a fairly simple financial decision-making check-list that you can use:
1. Are you saving at least 10% of your GROSS income? If not, do not buy.
2. Are you putting aside enough to meet your future obligations (e.g. college fund, donations, family medical expenses)? If not, do not buy.
3. Have you paid down all of your consumer / bad debt? If not, do not buy.
4. Do you have all of the right insurances in place and have you saved and put aside a 3 – 6 month buffer against emergencies? If not, do not buy.
5. Have you bought your first home? If not, do not buy.
6. Have you paid down your mortgage sufficiently (and/or has the equity risen sufficiently) to ensure that you meet the 20% Rule (i.e. no more than 20% of your current Net Worth as equity in your own home)? If not, do not buy.
7. Are you Investing at least 75% of your Net Worth? If not, do not buy.
8. Have you saved enough money so that you can pay cash for the item without changing your answer to any of the above and still meet all of your current commitments? If not, do not buy.
9. Can you afford to pay all of the associated expenses (insurance, repairs & maintenance, running costs) on the item without changing your answer on any of the above and still meet all of your current commitments? If not, do not buy.
10. If you have made it all the way to this Step without triggering a ‘do not buy’ …. what are you waiting for?!
… you’re a hard-working adult, if you really want it, go ahead and buy it … you deserve it!!
There you have it … 10 Steps to Whatever It Is That You Want, simply designed to ensure that you can buy the things that you want as long as you put things of lesser long-term intrinsic value (maybe of a higher emotional value) behind activities that:
Keep you out of the poor house, and keep you heading towards your ultimate financial goal. There is a short-cut if neither of these goals are important to you: Buy now and hang the expense!
But, I don’t recommend it 😉
Great post, AJC. I’m planning on making some purchases soon and will use this to help to decide whether or not to go forward. I’m frugal, but I believe in spending where it counts. E.g. I bought a $2200 massage chair, and you know what – it’s worth *every* penny! Another example is my bose wave radio. It’s a $400 alarm clock radio. Which is “expensive”. But the fact is: it takes up very little space, it’s elegant and I get a kick out of listening to the huge sound coming out of such a small box. Being the idiot that I can be sometimes, I broke it once – and you know what – I bought another one!
@ blogrdoc – You know, every time I go past a Sharper Image or Brookstone store, I just gotta sit in the massage chairs … trouble is that I haven’t found one yet to match the one that I tried in Japan, in terms of REALLY getting in there and massaging my kneck … I think I know how you broke your first Bose, but I’m not telling 😉
Great post. Those steps are pretty close to a “To Do” list as anything else I’ve seen.
Thanks!!!
@ Bill – I’ve been sprung! It was a pretty sneaky way of putting the carrot in front of the donkey: get your life in your order so you can have all the good stuff … without distracting you too much from the journe towards Your Number. Thanks for the comment!
@AJC, it’s actually a funny story, so I’ll go ahead and share it (totally true story):
I was listening to music on the Bose, and I got a little excited.
I jumped up and grabbed this ledge-thingy in my living room, intending to do a pull up sort of thing. (Don’t ask me why.) I swung my leg and my slipper flew off. The slipper flew across the room and hit a glass of water which spilled onto the Bose! Talk about a buzz killer.
@ blogrdoc – thanks for sharing … I knew it had something to do with “swinging a leg” but this isn’t THAT kind of a site :))
BTW: Let me know how the ‘checklist’ works for you …
With our new house, all additional expenses and upkeep, we are able to utilize 36% of our NET income to finish paying off debt and invest. Am I living above my means in only utilizing 36% of my net income to build wealth?
I suppose we could have paid someone valuable rent money to help them build their wealth for a couple of years, then purchased a house that cost just over 100k instead of just over 300k, but I really did think we were being responsible and moving toward our goals by purchasing a home that satisfied our “wants” for the better part of our lives, while only costing us 12% of our income per month in expenses and coming home ecstatic over our property everyday. I also figured that a 300k house while appreciating would be more equity to tap each year for investments than a 100k house. Any thoughts on this?
@ Docsd – If you are applying 36% of your net income (what is that of your gross?) towards your debt reduction / wealth creation plan, then you are doing well from a SAVINGS point of view. That’s like looking at a business’s Profit and Loss Statement, which only tells half the story as to how well the business is doing …
Most of the rules that I have given so far have focussed on the other half of the story: i.e. the Balance Sheet side of the equation; that is your Net Worth (what you own less what you owe).
The cardinal wealth-building rule is to have at least 75% of your Net Worth in INVESTMENTS (no, your house does not count, which is why we try and limit our equity in it to no more than 20% of our net Worth).
It is 27% of gross, and 36% of net, however, my wife and I have committed over the past 2 years to keep our cost of living the same and use 100% of our income increases for savings. This has occurred over the past 2 years and our cost of living (even after purchasing this new home) will not change because we now have an even lower fixed interest rate on the new home than we did on our first home as first-time buyers. When we started out a couple of years ago, we had over 70k more debt than now and made half the income we do now so that shows we haven’t lifted lifestyle any over the past 2 years, just accelerated debt reduction.
I understand what you mean from your last comment as looking at the other side of the equation and the goal is to get to the point of making leaps and bounds with investment capital ASAP.
I think the trouble is that we are just starting out(with me being fairly recently out of school and making it in practice now) and that we haven’t been really earning for very long so we don’t have large amounts of capital yet by default to fully fall into the 20% of net worth in home equity, currently with my student loans we have a neg net worth! lol. I just couldn’t see renting for a few more years to be honest and lose that rent money. However, according to our plan, we will be able to save close to 50k per year initially (not counting any increases in income, of which 100% of the increases will go toward accelerating this process as I really feel no desire in a lifestyle increase at all) This will very quickly become close to 100k of savings as I earn passive income from additional clinics that I am currently helping start up. All that income will be applied toward purchasing real estate, investing, purchasing businesses, etc..
Hope all this makes a bit more sense!
@ Docsd – Savings rate [Check!]; home purchase [check!] … you are doing well!
A small ‘hint’: don’t necessarily be in a hurry to pay off the student loans IF they are at a lower % than current fixed mortgage rates AND you are prepared instead to gear into some other investmments (maybe more real-estate).
Have a dilemma regarding is it a need or a want – I have a house now, student loans, bad debt 🙂 and need to decrease everything. I have a rescue Old English Sheepdog I’ve had now over a year and a half. Always meant to get a fence up, even prior to getting him, but had different expenses and no savings to cover them (hence the debt climb) and have put off getting a fence up. I’ve downscaled the fence to a smaller area, and using a split-rail backed up with rabbit guard (and chicken wire to prevent his digging out, since this OES likes to dig for fun) to contain him, get him off a lead, keep him out of the saplings and garden area, and allow him to see his neighbors (dogs) because he is a very social animal.
Under the 10 questions above, it doesn’t qualify as something to change lifestyle, but since it would change the dog’s lifestyle a bit (no longer tied to a 20′ lead, but given the ability to walk up and lie on the hill or in the shade, and note there is no doghouse – tho i’ve tried twice to get a useable one back there, and to find the dog some shade (all rigged badly). I think this is a need, but the question arose from someone else, so I will pass it to you since it is a financial decision as well. It’s not putting food in our mouths, but it is providing shelter and protection for the family dog who is also protection for us (single mom household). Or is this too left-field?
@ Diane – Follow the 10 questions exactly as written! Then come back on Tuesday … I’ll do a f/u post and you can let me know the outcome and how you feel about it … OK?
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