I’m reading and enjoying a book I got from a good friend for Christmas (“How to manage Residential Property for Maximum Cash Flow and Resale Value” by John T. Reed). Reed has a very pragmatic approach to life and investing, which I appreciate. One of his “rules of thumb” which seems like a good one, is only purchase something to save money if you’ll earn back the purchase price within three years.
He talks about this in the context of electricity metering and whatnot, but I think its probably pretty good universal advice. If you’re running a business and you’re thinking about investing in higher capacity machinery, if you’ll earn back the cost of the machinery in the next 3 years through the increased profit, get it, if you can’t don’t.
We encountered this situation at the building I’m a silent partner at. The active partner wants to install solar paneling. I’ve read about buildings that have installed solar panels and feed energy back into the grid (and get paid for it). It all sounds great, until I got to the part where it takes solar panels 20 years to save/earn enough to cover the costs of the equipment. Factor in the “time value of money” and you’ll never earn back what you put into it. Even though it would save us money every month, we’d never get back what we put into it, so it’s a dumb way to “save” money. I’ve told this to my buddy repeatedly, but he keeps bringing up the idea of installing solar panels every couple of months (I think he likes the idea of having a cutting edge building). We’ll probably eventually put them in (sigh). Down the road, solar panels will get more efficient (cheaper to make and/or more effective) and about the time they’ll pay for themselves in 3 years they’ll be worth installing in most buildings.
On a more personal level, if you’re doing something to save money around the house, make sure you’ll make it back in 3 years through savings. If you’re considering installing insulation, make sure the decrease in electricity spending will save you the cost of materials and installation over the first 3 years. If you’re considering putting a low-flow head on the shower, or installing a low-flow toilet, make sure the savings will be re-couped within 3 years, etc, etc.
What “cost saving” purchases have you made and how long did it take them to pay for themselves?