The Right and Wrong Way to Think About Spending

A couple days ago, Mr Money Mustache posted an interesting article on how he calculates the cost of large purchases. It was called The Twenty Dollar Swim and after reading the article I agreed with it, but after thinking about it for a few more days I started to hate it.

The premise is based on calculating the 18 year cost of ownership and opportunity cost of not investing in the stock market, then dividing it by the number of times you'd use the pool. 

His calculation is a pretty good summary so I'll just copy it here:

Sure, it's not wrong, all of those numbers are right and it's definitely jaw dropping, but it feels a little misleading.

If you take any significant sum of money and compound it for 18 years, of course you'll get a big number. That's kind of the whole premise behind saving for retirement and the reason that all of this stuff works. A little bit of money today turns into a ton of money later because it compounds.

Of course, when you spend money it works against you. You're giving up the power of compounding interest in order to get some benefit immediately like a haircut, some new shoes, or a new pool.

A Better Way To View Spending

At first glance, MMM's method might seem appealing. It definitely makes you want to stop spending money and save it for retirement instead which was probably his point. But if you view all spending through this lens, then it never makes sense to spend any money. It's always better to save and compound for 20 years until you retire.

But there's a better way.....

I came across this a year or two ago on /r/financialindependence and it's stuck with me ever since. Using the example above of buying a pool, you'd compare your timeline to retirement with and without the purchase of the pool.

Popping into Networthify, I'll enter my current situation:

  • Current portfolio - $165k
  • Annual savings - $30k
  • Annual spending - $40k

Ignore the income and savings rate numbers. They don't mean anything in Networthify, only savings and expenses matter.

This gives me a result of 15.5 years until retirement. Hold on to this number, we'll need it in a sec.

Now let's say I came into a $30k inhertiance and was trying to decide if I should buy a pool. Let's rerun the numbers with a portfolio value of $195k and see how much our timeline to FIRE has sped up.

So investing an extra $30k today will cut the time it takes to retire from 15.5 years to 14.7 years.

But what would happen if we bought the pool instead? Back to Networthify....drop the $195k back to $165k and increase the annual spending by $1.6k to account for the chemicals, maintenance, etc on the pool and see what you get:

Back up to 15.6 years. So installing a pool will delay our future retirement by 1 full year. Is having a pool worth 1 extra year of work? For some people, the answer might be yes.

But this is a much better tool than compounding numbers for 20-30 year time horizons and seeing your jaw drop at the huge amounts of money. Instead of shocking your brain with big numbers and deciding you'll never spend another dime, this way of looking at big expenses help you weigh the trade offs.

Deciding whether I'll quit working at age 45 or 46 reframes the whole decision. If you like your job and don't intend to retire as soon as mathematically possible, then a pool could make perfect sense. 

On the other hand if you hate your job and are counting down the seconds until you can quit, then maybe you'd rather have a year of your life back instead of a pool.

Do you have any weird hacks for thinking about your spending? Leave a comment, I'd love to hear about it.

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  1. Honestly I just avoid the context of the future and instead look at things relative and instead of.

    For example I spend X amount on a commodity a month. Is the value of a pool worth the same to me as X months of said commodity. Then I shoot wherever possible for a zero sum change in yearly expenditures outside of inflation. Ie I make myself trade something for something else. This of course assumes I’m already satisfied with my current sp being levels re my hapiness and savings. I am.

  2. You’re definitely not wrong here. I mean, I tend to go with the MMM approach on big spends and your method on the smaller more mundane ones. I don’t think anyone would be worse off by just taking a little longer before making any large financial decision.

    Thought provoking…

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