15th April 2016 –
If you spend any time researching Financial Independence or similar, one thing you’ll keep coming across is how the cost of one’s lifestyle is calculated. Unless you are budgeting and saving and investing a large portion of your income already you probably haven’t got a clue how much all of those little extras you enjoy each week are really costing you.
Since it’s going to take quite a number of years for most of us to reach our financial independence goal we therefore have to work out the cost of our current expenditure over the long term.
The rule-of-thumb most use is a ten year period. Therefore, we calculate our expenditure multiplied by 10 years, inflation costs over 10 years, investment returns over 10 years, and so on.
But we also use the same time period to calculate the savings we make from doing things smarter. Like changing all of our power-hungry incandescent light bulbs for LED or compact fluorescent, or riding our bike to work instead of using the car, or taking our lunch to work each day instead of buying it.
Not only do we have to work out the long term cost of our purchase but also the cost of the compounded interest we would have made by investing those dollars instead of spending them. Again, a rule-of-thumb rate to use is 7%, since this will be the conservative annual return from our investments.
Luckily, there’s all sorts of handy calculators available (like the this one) so it’s easy to find one that will tell us exactly how many months that daily latte you pick up each morning, is going to add to your working life.
So let’s take the example of the coffee that you habitually pick up every day. That’s $4.50 per day multiplied by 10 years = $16,416. However, the true cost, by forgoing the interest you could have made, means that it has really cost you $23,678!!
For a person living a reasonably frugal lifestyle, that could mean almost another year working instead of enjoying the lifestyle of someone who doesn’t have to go to work each day.
So, if you really want to make the change from your current spendy lifestyle, where you will be working until age 65, to one where you are going to retire 10, 12, 15 years earlier, you have to start thinking of all of your purchases as long-term. You have to start asking yourself, “if I buy this, how many more months will it add to my working life?”
Now use the same calculator to work out the long term cost of that magazine subscription, the gym membership you rarely use, the boat or jet ski that sits in storage most of the time. I think you’ll be shocked, and perhaps now you may start to see why you think it’s been too hard to save money.
So what would you prefer now. The daily coffee you buy out of habit anyway. Or the dollars that are going to get you to your goal of financial freedom even quicker?
Next week, 11 ways to start saving hundreds of dollars a year off your regular bills. You know the ones, mobile phone, electricity, insurance etc. that you’re probably paying far too much for month after month. See you then.