By Brad Thomason, CPA
People who advise others on finance often get asked how much money would be OK to spend on something unnecessary, like a big vacation, or a fancy car or something like that.
Once, while stuck in an airport terminal, I watched fifteen or twenty minutes of a program with a well-known host. I only watched for that long because I couldn’t handle any more, and started walking up and down the concourse to burn the time until the plane showed up, just to escape the TV.
It was the call-in portion of the show (or maybe they did that for the whole time) and pretty much every caller would give a quick verbal overview of his or her job situation, balance sheet, etc, and then ask the host if it would be OK for them to spend $X on something unnecessary. Inevitably, a two or three minute tongue-lashing would follow, in which the caller was told “no.”
I guess maybe I’ve been doing it wrong, because in all of these years I’ve never told a client that he/she couldn’t spend money on something, much less lectured them about their manifest financial irresponsibility for even asking. Your money; spend it on whatever you want to. Neither my job nor my prerogative to tell you that you can’t.
Though in fairness to the host, in every case the person doing the asking really didn’t have the sort of financial position where the frivolous extras being batted about were a real good idea. Ending up with more money in your bass boat than your 401(k) account is not broadly understood as a step in the right direction.
Well, rather than dragging us into all of that, how about I just tell you instead how to figure out the answer for yourself. This is actually a pretty quick one.
Most people come at the question in a form that resembles, “I wonder if it would be OK for me to spend $5,000 on a vacation?” Or $10,000. Or a horse, instead of a vacation. Or whatever.
Point being, they pick a dollar amount and a target for the money.
Let me suggest a different approach.
Assume that what you make in a year equals 100. Further, let’s stipulate that by the time you finish paying the bills (including your taxes) and enjoy a bottle of wine here, a steak there, few other little extras, you’ve gone through, say 75. On top of that, you’ve determined that you need to be putting back 14 every year towards retirement.
So all else being equal, once you’ve met the basics plus a little, you’ve used 89. What about the other 11?
Whatever you want. It’s your money.
Return to your initial question: is your personal version of “11” enough to pay for that thing you were asking about?
In other words, don’t ask the question without any real context on the situation. Instead, make a rough sketch for what you might have to work with first, then start considering the specifics of how to allocate it. Much easier that way.
Also, understand that the problem with pressing the “expert” to just-answer-the-question comes down to the fact that this is a nuanced matter, hanging squarely in between a pair of oppositional forces which we have now discussed on several occasions. Simple answers to complex matters are seldom helpful, so it’s best not to even go down that road in the first place.
It is quite literally the case that every dime you spend pre-retirement is a dime that will never earn you a return, nor be available to spend once you do retire.
But it’s also true that it is mighty hard to live a life in which you ascetically beat the joy out of every little thing.
Civility and even enlightenment seem to make a soft plea for some middle ground, here. So how much middle ground is there to actually work with? Reference above calculation.
The reality is that you will probably never be able to state with certainty that it is perfectly OK to blow some money on something you don’t need. In other words, to say “of course I can afford this, and there will never be even a hint of negative ramification in the future.” Not if it’s more than a couple hundred bucks.
But you can certainly come to an understanding, pretty quickly, that you really can’t afford it. At least not at the moment. That’s the more important finding.
Beyond that, even if it looks like it won’t wreck you, you may decide that using a bit of the extra to do a little extra on your savings contributions this year would end up giving you just as much satisfaction as the other thing. That also sets the stage for the potential of bigger excesses in future years.
Either way, it’s really not that hard to figure out. So you figure it out. After all, it’s likely to come up again in the future, and the TV guru might be off on an ostrich-watching junket, or flying around in a hot air balloon, or something; and in the end you’d just wind up having to decide for yourself, anyway.
By Brad Thomason, CPA
Here is a stupid argument: you should not invest in x because you can make more money by investing in y.
Now, I’m betting when you read that sentence, one of two things happened. One possibility is that you nodded your head and thought to yourself, “Yep, I know where he’s going with this.”
Or, you thought, “I don’t know that the argument is stupid, but the fellow doing the writing sure sounds like he is.”
Touché. But let me see if I can persuade you over into Group 1.
The reason it’s a stupid argument is because it inherently pre-supposes that how much money you make, the rate of return, is the basis of the decision, the most important consideration.
It is fair to say, and I will readily concede, that how much money you make will likely never be an unimportant factor. But that doesn’t mean it’s the most important. Not always.
Risk also matters. So does liquidity. There might be some aspect of timing that matters. In a particular case, there might be special factors to take into account. It’s complicated; or at least sometimes it is.
As you approach retirement, it becomes more important to think about shifting your holdings to less risky assets, and ones that have low levels of complexity. You want predictable results, you want low odds of loss and you want it to be easy if someone else has to step in to help you out with managing your affairs. That’s true pretty much in all cases. In the ideal cases, doing so is more palatable because the job of building the wealth to suitable levels is already done at that point.
The fact that you are taking an action which likely diminishes your earnings capacity is easier to live with, because you know you’ve won, and now it’s time to get off the field and use what you have to pay for some remaining years of peaceful existence.
Of course, getting more money is a benefit. But benefits come in other forms, too. That’s why, to simply pretend that the yield is the only thing that matters, is stupid. Because it’s not.
Stock and mutual fund guys have been using this line of argument to beat up on bonds and annuities for years. Don’t do it, they say. You can make more if you leave your money in the market. Dance with who brung ya, and all that.
Perhaps you could. Perhaps. But it isn’t a certainty. Getting what you expect from a bond portfolio is more likely. And getting what you expect from an annuity contract actually is about as certain as it gets, as a matter of law.
Anyway, I’m not going to try to convince anyone that money doesn’t matter and that having more of it isn’t a good thing. But don’t let anyone else convince you that it’s the only thing that matters, ok?
And should they try, you might ought to factor that into your decision about whether to listen them on other topics, as well.
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