The future cost impact
I want to retire early to travel the world. Yes, I know, you can’t go anywhere without someone telling you they plan to retire early. I’m not giving myself an age that I want to retire. I’m still enjoying my job and will continue working as long as I do. Eventually I want enough money for it not factor into decisions I take to enjoy myself. That is why I measure every financial decision I take today, based on the effect it will have on my future cost.
I don’t like using the term retirement since that is not my goal. I want early financial independence. My retirement will probably be a series of side hustles. I might even work on and off sometimes. But that is not the point of today’s article. Today I want to talk about how I evaluate the financial decisions that I take daily. Imagine you are going to spend R1 000 today. It doesn’t matter what you are spending it on. Let’s say it is to hit golf balls into the ocean. I do not want to discourage anyone from hitting golf balls into the ocean though. It sounds awesome, but think about the dolphins.
If you invested that R1 000 in the shares, you would probably achieve a return of 12% in the long run. I’m 30 now and conventional wisdom says that I will be financially independent at the age of 65. That leaves me an investment horizon of 35 years. Investing a thousand rand at 12% for 35 years racks you up R52 800. However, that’s not a fair comparison since it does not account for inflation. If you reduce R52 800 with 35 years’ worth of inflation at 6%, you get R6 870.
In other words, every R1 000 you spend today, is reducing your independence savings by R6 870. To simplify this further what you spend today, means 6.87 times more to you in retirement if you are 30 now. This is obviously time-dependent, so as ballpark figures you can use 12 times if you are 20, 7 times if you are 30 and 4 times if you are 40.
Future cost example
Now let us evaluate the future cost of a purchase you need to make. You need a laptop for working on excel and word. You can either buy a new Lenovo for R7 500 or the latest MacBook Pro for R32 500. That is a price difference of R25 000. Taking our ratio of 6.87 that we calculated, this means that buying the MacBook instead of the Lenovo has a future cost impact R 171 750 in retirement. This sounds like a lot of money, but what does it really mean to you?
I’m going to assume you need R30 000 per month in today’s money for you to cover your expenses. So, R 171 750 will allow you to retire just under six months earlier. So the question you really need to ask yourself is, “what is having the latest Macbook worth to you?” If the answer is that the laptop is worth working an additional 6 months before you are financially free, then buy the Macbook. If you only had to purchase a laptop once in your life, it would not have such a big impact on your financial independence. Odds are, however, that you will need a new laptop every five years. If you consistently choose the MacBook, your decision can literally add years that you need to work extra before you are financially free.
This simple future cost calculation gave me a new outlook on what I purchase and what I really need. I know that sometimes you cannot avoid big purchases. I am also assuming that you are not a graphic designer that almost certainly need a MacBook to be able to do your job. The only point that I’m trying to make is that you need to think about what is important to you and to be aware of what that financial decisions are costing you.
Article reposted with permission from the Tigers on a golden leash blog.