According to the mainstream media in both Canada and the US – we are in the midst of a terrible recession. Stock market crashes, layoffs, increasing unemployment mean that lifestyle inflation is not something that most people have to worry about. Or is it?
In my case, my investments are doing fairly well, I still have my job, no permanent pay cuts and I have a side business which did reasonably well in 2009. The fact is that 2009 was the best year I’ve ever had financially.
My wife and I have identified some financial goals that we would like to achieve over the next 5 years or so. The main ones are:
- Pay off the mortgage.
- Max out my rrsp room.
We’ve been pretty good about watching our spending and keeping our eyes on the goal but it is hard to not just start spending more. There are unfinished renos/fixes around the house that I would love to hire someone to do. Our tv is a 27″ CRT (the old tube style) which still works ok but it would be nice to upgrade to a shiny new flat screen.
Since we are not hardcore about reaching our goals before loosening the purse strings a bit, I’ve been thinking about how to analyze potential purchases. It seems to me that one way to think about purchases/expeditures is to divide them into 2 categories.
1) Where you commit future money in the form of debt payments or regular fees.
Examples might be where you buy a bigger house/car – property taxes, utilities, insurance, maintenance, debt payments. Large reno. vacation, any other spending which is on credit.
Non-debt future payments could be on something like:
Sign up for some membership such as a gym – monthly payments.
cable tv service, internet service. Costco – other clubs.
The problem with this type of lifestyle creep is sometimes it can’t be easily undone or changed. Debt has to be paid off, a house or car that is too expensive can be sold but that is a lot of work. This adds risk to your finances and sometimes you can get into trouble if your income is reduced and you have trouble making your payments. Things like houses are not all that liquid and if the value has gone down significantly then selling might not solve your problems.
Some ongoing fees can be reduced or cancelled such as cable tv.
2) One time expenditure – no future obligations.
These are items where you just have the one time cost which you don’t have to borrow. Entertainment, nice dinners, vacations, any other items that you have the cash for such as furniture, renos.
In my mind this is a different type of lifestyle creep that is less risky is where you spend money (where you have the cash) on things that have no future commitments.
These lifestyle luxuries may not do much for your financial standing (except maybe renovations) since you are basically trading money for “experiences” but if nothing else you can stop that kind of spending on a dime if necessary. Yes, mentally it might be hard to stop eating out or have to cut back on vacations but the choice is yours.
The dilemma that I see is that items with future commitments are often items of lasting value so they might not be poor financial decisions. A house is a great example – while they can go down in value and do, it’s not likely that your house will lose the majority of it’s value. Even if your house value does go down a lot it might not matter much as long as you can still make the payments and don’t want to move.
A car is another example of lasting value – yes, it does depreciate but not overnight.
The problem with spending money on items with no future commitments is that they are often of no value once you purchase them. Any money spend on nice dinners, entertainment and vacations is completely gone since there are no remaining assets of value.
It seems that borrowing (leveraging) to buy assets that hold their value or appreciate will lead to greater wealth down the road as long as your income can be maintained. If you have reduced income for any length of time then you could lose a lot.
On the other hand someone who spends a lot of money on items of no monetary value may not have a great finances since they might not have any real assets but they also don’t have much in the way of commitments so they can survive a reduced income fairly easily.
Anyway, for future large purchases I’m going to try to consider the following:
- Do I have to borrow? Borrowing means future obligations which means more financial risk.
- Are there on going fees? Signing up for a gym/club membership might not cost anything up front but your cash flow will be reduced until said membership is cancelled.
- If I buy a new HD tv then do I have to upgrade my pvr as well as my cable package? If I get a new car (with cash) will the insurance/gas costs go up?
- How quickly will the item depreciate? This obviously doesn’t apply to consumables but do things like furniture, new cars, a nice tv retain some portion of their value for a time?
- Will this purchase delay retirement? I’d love to be financially independent at some point and every penny I spend or commit to spending in the future delays that date. If the purchase is large enough then it will delay retirement.
- Do you apply any kind of selective thought process before committing to new purchases? Do they work?
It’s hard to come up with any kind of financial “rules” out of all these different thoughts but I did manage to come up with the following:
- If you are regularly spending more than you earn then try not to commit any future money to things with ongoing payments. Ie just overspend on things like restaurant meals (which can be easily stopped).
- If you are living well below your means then you can not worry about future commitments as much. Buy a house, join a gym etc.