Welcome to the fifth article in the series, Conserving Money. This article discusses financial decisions and their cumulative impact on financial freedom.
Financial Decisions
When I reflect on my financial performance through the years, I find both great decisions and plenty of poor ones too. Whether it’s purchasing, saving, or investing, you will always find winners and losers in your portfolio. People love to talk about the winners. “Hey, I really hit it big on this stock.” or “Whoa, you should have seen me at the track the other day!” is what you might hear at a friendly gathering. On the other hand, people rarely pull out their losers for show & tell and give you, “Let me tell you about the bargain house I bought which was filled with termites!”
Here is the point. I, like everyone else, have made some good financial decisions and some poor ones. Just ask my wife. Once she stops giggling, she will happily tell you about the hearing aid stock or the biotech company that was going to make us rich but never did. Once I set aside the losers, I reflect upon the good choices I have made. In particular, I narrow it down to two standing apart from the rest. Today, I would like to tell you about one particular financial decision in the hope I may persuade you to follow the same path.
Finances are your Personal Business
Your financial portfolio encompasses many different attributes. In fact, you may think of your portfolio the way an entrepreneur thinks of doing business. Personal finances include revenue (wages/income), earning potential (sales & marketing), cash flow (savings), costs (bills/expenses) and growth (investments). Wealth is successfully accumulated by focusing on all of these areas and balancing how you earn, spend, save, and invest.
As Jack Engelman pointed out in his budgeting article, a budget’s goal is to balance revenue and costs in the present and provide funds for future growth. In order to grow your wealth, you need save enough money to be able to purchase investments.
Two Broad Types of Investments
As an individual, you purchase two broad categories of investments, based on your investment objectives. Let’s talk about these types of investments and how they contribute to building wealth for your future use.
First, you invest your money to provide stability. These investments are safe and they grow at a slow rate. Examples include a house and interest
A second investment category involves purchasing more speculative offerings like rental property, stocks, mutual funds, precious metals, and the like. These investments offer the potential of significantly higher growth, and with it, they bring along more risk to the investor. A portion of your savings should be allocated into these types of investments, after thoroughly researching options and determining their suitability for you.
Both types of investments follow the same premise. Find potential investment vehicles and allocate some of your savings into them in an effort to grow your money, or appreciate your portfolio. As you are able to invest more money into investments, you can diversify a portion toward more risky and speculative instruments to further speed up the appreciation. I plan to discuss this topic further in future articles.
Expenses are not Investments
Notice, when I discussed investments, I did not list automobiles. Do you know why? Unless you are buying a rare, collector car, an automobile’s value is not going up. Ever. That disqualifies it from being an investment and classifies it as a cost or expense. That is not necessarily bad, but, hopefully, it casts
Now, let’s talk about one of the best financial decisions I have made in my life: Do not allocate more money to expense items than investment opportunities. Look to spend as little on expense items as possible and take the additional funds and invest them.
Investing in expense items will never make you wealthy
What does this mean in practical terms? Buy high-quality expense items at a discount, when possible, and hold on to them and maintain them well to make them last as long as possible. For cars, I have had great fortune buying quality cars, either new or used, and keeping them for 8-10 years. I keep them in a garage and have a trustworthy mechanic to keep them running properly and lasting for years. I think I have really nice cars, but they are not always new. This strategy has aided my investment portfolio tremendously throughout my life.
Let’s Go Through an Example
I hear you saying, “That sounds great for you, but I do not see that making a huge difference for my financial picture.” Let me show you why that is simply not the case. Here is an example to illustrate the difference between holding expense items long-term versus short-term. Let’s take a look at a scenario using two people’s car buying behavior to demonstrate the point.
In our example, 2 different people each purchase a $25,000 Toyota Camry and pay for it with a 60-month, 4% auto loan. The car with interest will cost $27,600 when the loan is paid off. After 5 years, the cars are now worth $10,000 for a trade-in. The first person trades in the car and buys another new car, this time for $27,000 (inflation). The second person decides to keep the car and invest the car payment amount of $5,520 per year into a suitable investment yielding a 6% return.
Breakdown: Buying 2 New Cars vs. Buying 1 New Car in a 10-year Window
| PERSON #1 | PERSON #2 | |
| Years 1-5 | -$27,600 | -$27,600 |
| Car Value | $10,000 | $10,000 |
| Years 6-10 | -$18,780 | +$27,600 |
| Investment Gain | $0 | +$2,610 |
| Car Value | $12,000 | $3,500 |
| Net Expense | -$34,380 | +$6,110 |
Yep, that’s right. The difference between buying two moderately priced cars in 10 years versus one car in the same period is over $40,000! I love new cars but is a new car worth that amount of money? If you live in a two-car household, the difference would be $80,000 every 10-year period. Compound that amount over your 40-year working life with two cars, and you are talking well over $320,000 more to be in Scenario 1 as opposed to Scenario 2. That amount of money pays for many wonderful vacations or other once-in-a-lifetime opportunities.
You can argue with the assumptions I am making in the model. I know I left out maintenance costs and I am using a relatively low rate of return. The price of the car will also change the calculations dramatically. All that aside, I want the focus to be on the big picture. The compounding of interest payments and negative impact of turning over assets too quickly negatively affects funds available to invest, The more frequently you purchase expense items; the bigger the drag will be on your ability to invest money and grow it.
Expense Items will Never Make You Wealthy
Buying expense items and selling them too quickly forfeits the opportunity to take those funds and invest them. I would much rather take some of those funds and put them toward an investment that will grow and increase my wealth opportunity. Expense items that depreciate will never make you wealthy.
Bottom line, buying expense items and flipping them will force you to forgo a great deal of investment income. The more quickly you flip them will exaggerate the outcome. For example, leasing a car for 24 to 36 months compounds the difference significantly beyond the $40,000 calculated in the above example. By leasing, you are paying the most money to drive a depreciating asset, and therefore, you are diverting the most funds away from investment in your future.
Your financial freedom and independence depend on getting funds invested. If you are constantly putting your funds toward purchasng expense items, you will never get funds working for you and your future. Building wealth will remain an arm’s length away. Sometimes, we do not understand the impact of our decisions until you see them on paper and you can reflect on them with time. I can see directly the positive impact of deferring purchases has made to my ability to invest. It definitely ranks as one of the two best financial decisions I have made in my life.
In a future article, I will discuss the other financial decision I made that stood apart from the rest to make a significantly positive impact on my future. Stay tuned!