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Learn how to prioritize your spending following the 10 essentials and 6 questions to ask yourself. This will keep you growing your net worth and keep you away from impulse spending.
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Q. My husband Tom and I follow your podcast. He is a car mechanic and told me he wants to buy new handlebars for his motorcycle. It will cost $1800 because it involves additional parts. The funny thing is, he plans to sell the motorcycle! I reminded him about opportunity cost. What more help can you give me to explain why he shouldn’t buy this?
Thank you, Sue
A. Sue, I appreciate your email and that you and your husband are listeners! Thank you for that. You did the right thing to remind him about opportunity cost. Here’s the deal: putting $1800 handlebars on a motorcycle you plan to sell is like flushing that money down the toilet. You won’t get it back when you sell the bike because someone else probably won’t appreciate the new handlebars to pay $1800 more. As long as the motorcycle operates well and looks nice, a buyer will want to pay the lowest price they can. They’ll look at comparable bikes with similar mileage and see what they are selling for and that’s what they’ll offer you.
Let’s look at how to analyze whether or not this is a smart purchase. We’re going to do that by prioritizing how we spend money so that it is spent on the things that matter to you, not things that are impulses and don’t really mean anything. That way your money is going toward the things you value and away from the things you don’t value.
When we look at your financial obligations, they are the same for just about everyone:
1. Home/shelter
2. Food
3. Kids
4. Retirement savings
5. College savings
6. Transportation
7. Utilities
8. Insurance
9. Clothing
10. Entertainment
These are the 10 basic expenses everyone has. If you don’t have children, then obviously the categories of kids and college don’t apply to you, but everything else does. Notice I didn’t put elective items like “travel” on the list, because it’s elective. These are the 10 basic things you pretty much have to spend money on.
Now, what do you value and want to spend money on? In other words, what would you choose to do with extra money?
Here’s what you can do to bring yourself back from the brink of impulse spending and into the realm of spending on your priorities.
1. Make a list of your spending priorities. Do this with your spouse so you’re on the same page. Start with my list of 10 items and break them down even further. You can break down entertainment into eating out, travel, TV, sports, etc. What is important to you and where do you want to spend money? If you like going to professional football games and having season tickets, then make that a priority.
2. When you want to make a purchase over $1,000 ask yourself where it fits into your spending priorities. Is it on the list? If it’s not, think about why you want to make that purchase.
Ask yourself these 5 key questions:
- 1. How will this enhance the quality of my life? If it won’t (I don’t think the handlebars pass this test) then pass on the purchase.
- 2. Will this extend my life, marriage, or health? Anything that will add to life, marriage and health should be a priority (however, be careful because you can justify things that you don’t really need. You might try to justify the time share is a “yes” here, when it’s really the annual vacation that’s a yes, not the timeshare).
- 3. What is the opportunity cost of this money? Calculate it by going to MoneyChimp.com, click on Calculate on the black bar, then put in the principal, rate and years. Click “calculate”.
- 4. Will this keep it’s intrinsic value and also increase in value over time? Again, be honest and realistic. Tom might think the handlebars will get him more money for his bike, but the reality is, they won’t.
- 5. Is this more important than my kids’ college or my retirement? The answer is usually “no”. But I’m not about deprivation, I’m about balance. So what is a compromise? How about if Tom didn’t buy the handlebars and sold the motorcycle like he planned, then reinvested the money into a fixer-upper car that he could have fun updating? That would provide a return on his investment instead of flushing the $1,800 down the toilet. That $1,800 plus the proceeds from the motorcycle could launch him in a new business that he loves and be lucrative at the same time.
- 6. Will this increase my net worth? Always having an eye on what can increase your net worth, will help you continue to build wealth and reach your financial goals and financial freedom. If you’re not building your net worth, you’re not becoming financially free, it’s that simple.
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