Woman Shopping - Holding Shopping Bags - Retail - Spending Money

What Does it Mean to be Able to Afford Something?

Intro

Most everyone will agree that you shouldn’t buy things that you can’t afford, yet so many do. Why is that? It seems to us that one of the reasons for this is because many don’t know what it means to be able to afford something. Spoiler alert – it doesn’t mean you have enough money in the bank or have just enough income to cover it.

Depending on your situation, it’s probably not worth a lot of stress in your life to ponder whether you can afford one brand of toilet paper over another. However, when it comes down to larger (e.g. home, car, education, wedding rings, etc.) or more discretionary (e.g. vacation, TV, home remodeling, etc.) purchases, you should always determine how much you can afford to spend before you spend it.

Although the focus of this article is on spending, note that some of the references to “spending too much money” may be substituted for “not making enough money”. Making and spending money are both part of the cash flow equation, so if you’re having a cash flow problem, you can solve this either by cutting spending and/or increasing income.

Podcast

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Hey everybody, welcome back to the Bigger Insights Finance podcast where we’ll help

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you live a life you don’t need a vacation from.

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Most everyone will agree that you shouldn’t buy things you can’t afford, yet so many

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people do.

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Why is that?

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It seems to us that one of the reasons for this is because many don’t know what it means

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to be able to afford something.

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And spoiler alert, it doesn’t mean that you have enough money in the bank or that you

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have just enough income to cover it.

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In this episode, we’re going to give you some things to think about when you’re doing

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your budgeting, financial planning, or considering making a large purchase like a home, car,

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wedding, etc.

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I’m going to start this off with a personal story, but first, just bear in mind that this

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episode is for educational purposes only and is not financial or other advice.

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When I was in college, one of the things I noticed was that my friends had this burning

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desire to go out and buy a nice car when they graduate.

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Some even went so far as to convince a dealer to sell them a car on the promise that they

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would get a good job after they graduate in a few months.

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I did not do that, but instead opted to keep my beater until it became embarrassing and

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I had some concerns about how reliable it was going to be.

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So when that day finally came, I decided to buy a new car, but had a problem.

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How much car can I afford?

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I honestly had no way of answering this question.

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My income was pretty solid and my expenses were relatively low, so technically I could

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have “afforded” a pretty decent car. But you know what they say, “Just because

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you can, that doesn’t mean you should.”

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What I decided was that I should set my budget based on a share of my cash flow.

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Alright, that’s cool and all, but what even is my cash flow?

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I had a rough idea in mind, but when I actually sat down to calculate it, the real number

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was significantly less than I thought.

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This is a life lesson for the one or two of you who actually listened to this podcast.

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If you’re going to base financial decisions on your cash flow, make sure you sit down

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and calculate and be honest about what that number actually is.

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The mistake that I made and a lot of other people make is that I was just casually ignoring

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intermittent expenses.

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So when you think about your cash flow, what comes to mind?

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Mortgage or rent payments, food and energy, phone bill, OnlyFans, you know, the necessities.

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That’s a great place to start, but you also need to factor in intermittent expenses like

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buying a new car, replacing your roof, replacing your HVAC equipment and so on.

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That might sound obvious to you, but it seems to us that very few people do this because

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if you actually sit down and analyze how they manage their finances, their decisions essentially

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take only their regular expenses into account.

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It’s very obvious that this is what they’re doing because anytime something breaks, there’s

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no money to fix or replace it.

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You know, what was your strategy – that everything would be okay as long as nothing bad ever

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happens and nothing breaks?

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So when you calculate your cash flow, make sure you’re accounting for future intermittent

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expenses as well.

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Personally, I have a workbook where I project these things.

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It includes not only my regular expenses, but everything from buying a new car every

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X number of years, to replacing the car’s batteries and tires, buying new computers,

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NAS systems, etc.

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It is pretty straightforward.

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I calculate this on a monthly basis.

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So if I need to, for example, renew my driver’s license every four years, I just divide the

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expense by 48 months.

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You should really do this as well because depending on your situation, these other expenses that

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might not be on your radar could be costing you hundreds or thousands of dollars per

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month over the long run.

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So now let’s talk about how much you can afford to spend.

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This is a highly personal matter, which if you’re not familiar with our work, we help

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our clients with issues like this in one-on-one consulting sessions.

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Those are done almost entirely over the internet, by the way.

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So don’t think that we can’t help you if you’re not in the Cincinnati area like we

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are.

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But how much you can or should spend depends on a number of factors like your age, goals,

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income, assets, liabilities, family situation, health situation, risks, and risk tolerance.

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With regard to risk, we believe this is one of the biggest factors that people tend to

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ignore, which leads them to overspend.

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Ask yourself these questions.

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1.

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Will I be okay if I get laid off and it takes a while to find a new job or start a business?

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2.

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What if my spouse divorces me?

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3.

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What if I have a serious health issue?

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4.

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What if I have an unexpected child?

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5.

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Is your wealth growing fast enough to afford a decent retirement?

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And so on.

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Do you have the assets and insurance to help prevent these kinds of issues from bankrupting

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you?

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If not, we’re is the opinion that you’re already spending too much money because chances

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are you’re going to run into some of these issues at some point in the future.

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Goals are another area of concern.

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You may not have a solid financial plan, but you probably have some idea as to what

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you want or what you think your financial future should look like.

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We can sit down with you and help you quantify this, but let’s suppose for the sake of example

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that you need to be saving and investing about $5,000 per month to meet your financial

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goals.

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That might sound like a lot, but when you consider how many people are approaching retirement

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age and have no retirement savings, even that might not be enough.

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But anyway, let’s say that you’re really only saving $2,000 per month.

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Many people would see that and think that you have $2,000 a month that you can afford

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to spend.

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We don’t see it that way.

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In your case, you either need to cut your spending by $3,000 per month and/or increase

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your income to hit that $5,000 target.

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This is a very serious issue.

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I believe I read somewhere that you and a spouse need something like $350,000 in retirement

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to cover medical expenses alone.

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So take this very seriously.

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You can F around today, but you’re eventually going to find out.

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Now let’s talk about how you make your money.

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This is important because believe it or not, a lot of people hate their jobs, work an unsustainable

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number of hours, or make their money using skills that are soon to become obsolete.

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If that describes you in any way, you really need to be careful.

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We see this a lot with professional athletes, people in the adult film industry and so on.

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They make good money, but their income situation is rather “transitory”, as Jay Powell might

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put it.

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They don’t take that very seriously, spend like Congress, then are shocked to find out

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that they’re broke as a joke when they get a little bit older and can no longer perform.

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But it’s not just ballplayers and adult film stars that should be concerned about this.

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If your job requires hard labor or takes a large toll on your body, you need to account

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for the possibility that you may not be able to work as long as you’d like.

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But even white collar workers should be thinking about this as well.

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What if ChatGPT replaces you?

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What if you work in the crypto industry and it gets crushed by Big Brother? You need

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to be asking yourself these kinds of questions.

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One of our favorite justifications we hear is, “I deserve it.”

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“I bought my ‘forever home’ because I deserve it.”

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That makes me cringe when I hear this.

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Whenever someone tells me that they bought or they’re buying their “forever home”, I’m

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thinking to myself, “You’re buying being forever in debt.

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That’s what you’re buying.” Because what they mean when they say this is, “Yeah, I’m spending

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way too much on this, but I plan on being here for a while, you know, as long as

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nothing bad happens, in which case, I’ll probably go bankrupt and live under a bridge.”

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That’s what they’re actually saying.

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But let me go back and talk more about working long hours.

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When people buy their “forever home” or just spend too much money in general, they often

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compensate for this by working more hours. And we really don’t like this strategy for

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a few reasons.

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1. You’re going to suffer from burnout eventually.

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2. You’re going to get absolutely hosed on taxes.

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And 3. When you’re experiencing pre-burnout, you’re going to start splurging on things

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like Teslas, homes you can’t afford, $3,000 massage chairs, boats, etc.

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because you work really hard and “deserve it.”

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And when people do this, the expenses and taxes pile up.

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So what do they do?

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They work harder.

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They work more hours, which just reinforces this spending doom loop.

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You see what I mean?

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Stop buying things just because you feel like you deserve to treat yourself and instead

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focus on a plan. Because if you don’t, you’re at high risk of waking up someday in your

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40s or 50s and switch your mindset from, “I deserve a $3,000 massage chair” to, “Holy crap,

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I’m never going to be able to retire.”

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Now let’s talk about need versus afford.

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Sometimes we see clients and others spending too much on things they “need”, or they think

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they need. Because they need those things, the price becomes no object.

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Unfortunately, it is the case that at times we do need things that we can hardly afford,

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but that shouldn’t be used as an excuse to drop the ball on your financial planning.

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So you might be living in an expensive area and spending half of your income on rent,

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for example. You might be thinking to yourself, “Well, I need a place to stay.

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So it is what it is.

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I can’t get ahead because of greedy landlords.”

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Well, it is true, you do need a place to live, but is there really nothing you can do about

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it?

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Perhaps you could work extra hours or build a side hustle.

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Can you move to a cheaper area?

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Can you prepare your own meals rather than using DoorDash?

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These are the questions you should be asking rather than just say, “It is what it is.”

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And along these lines, are your needs actually needs or are they wants?

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Have you ever noticed how a lot of couples rush out to buy a nice seven-seater van or

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SUV immediately after having their first child or in some cases before it’s even born?

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Do you really need that?

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Does that expense actually make sense?

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Do you really need to buy a $1,200 phone every two years or a $2,000 MacBook to check

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your email, watch TikTok videos, and post bathroom selfies on Instasham?

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Probably not.

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So before you write off these expenses as fixed, check your assumptions.

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Of course, no one ever got rich by pinching pennies, but being wasteful isn’t going to

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fulfill your dreams either.

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Now let’s talk about dealing with salesmen because they can be very effective at getting

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people to spend more than they should.

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A salesman’s job is to make sales.

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It’s your job to do what’s in your best interest.

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When you deal with salesmen, you’ll hear things like, “Oh, based on your income, your home

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should be about $450,000.” Or “You can afford this $50,000 car”. Or “If you’re having trouble

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coming up with a down payment, take a loan out on your 401k!” “Or your engagement ring should

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be 20% of your annual salary.”

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Have you heard some of these before?

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The problem with this is that the salesman doesn’t know your situation or your goals.

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His only concern is making the sale and whether you’re going to be able to pay.

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If closing that transaction wrecks your finances, that’s not on him, that’s on you.

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One of the ways to help with this is to think about what you need and how much you should

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spend before you go shopping.

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This goes back to my situation when I was in the market for a car.

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I had some models in mind and a budget and I stuck to it,

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salesman gimmicks not withstanding.

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So when you go to the dealer to buy a car, come prepared. And if some new information

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comes to light, you can always sleep on it rather than make a knee-jerk decision.

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The second tip is to know who the salesman are.

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A salesman doesn’t always have “sales” in their title.

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As far as we’re concerned, anyone who’s trying to encourage you to spend money at their business

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is a salesman.

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There’s nothing wrong with that, but the point is that you need to understand what their

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motivations are and challenge what they’re telling you.

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So this will include insurance agents, realtors, mortgage brokers, bankers, and sometimes even

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professionals that should be looking out for your best interest rather than just trying

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to rack up sales.

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Sometimes we’ll see doctors and lawyers, for example, suggesting services that you don’t

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really need or that aren’t appropriate for your situation just to make those sales.

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And you might not think of those people as salesmen, but they are.

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Take realtors, for example, making tens of thousands of dollars to list your home and

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show up at closing to take their check.

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I was talking to a realtor once and I asked him why so many buyer’s offers do this little

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gimmick where they offer a high price, but with the seller chipping in closing costs.

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So an offer on your house might be $510,000, but you pay $10,000 for closing costs.

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And you think to yourself, “Well, what’s the point in that?

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Why not just make it $500,000 because that’s what it is.”

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So I asked my realtor about this and he gave me some BS reason that made absolutely no

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sense.

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The real reason is because that it inflates the sales price, which is what the commission

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is based on.

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So your realtor and the buyer’s realtor have this little scam going where they try to pump

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up the price at your expense, which results in you walking away with less money.

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Now keep in mind that this person is supposed to be representing you, but again, they’re salesmen.

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And if you’re not following what I’m saying, here’s how this little scam works.

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So if you accept that offer, the agents would split their commission on a $510,000 sale,

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even though the sale is really only for $500,000 on net. At a 6% commission that allows them

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to scam an extra $600 out of you, the seller, for no reason whatsoever.

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And by the way, that might also mean more transfer taxes to the county, depending on

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where you live.

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Aren’t realtors great? They’re just looking out for you.

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But seriously, someone really needs to investigate this whole racket, let’s be honest.

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But anyway, tip number three, be very wary of letting salesmen or financial gurus tell

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you that you should be spending amounts on your home, car, and other large items as a

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percentage of your income.

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One of the things that makes financial planning so tedious is that everyone’s situation is

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different.

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00:16:58,280 –> 00:17:03,120
So when a salesman tells you that you should be spending 30% of your income on housing,

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for example, if anything, you should see that as more of a limit rather than a target.

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But from our observation, people see these kinds of rules of thumb as targets, not limits.

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00:17:16,800 –> 00:17:22,160
So if a salesman tells you that your engagement ring should be 20% of your income, and you

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00:17:22,160 –> 00:17:30,000
make $100,000, if you’re like most people, you’d be thinking, “What can I get for $20,000?”

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00:17:30,000 –> 00:17:36,580
We don’t recommend these kinds of mental gimmicks because again, everyone’s situation is different.

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We hear this 30% rule for housing a lot, but that may be too much for your situation.

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Given your goals, assets, liabilities, etc., maybe you can only afford to spend 20%.

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00:17:50,760 –> 00:17:57,340
Maybe you really can afford 30%, but you’d be just as happy spending 20%, in which case

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if you did spend the 30%, you would have an opportunity cost.

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If you’re not going to develop a comprehensive financial plan, we’re a fan of the following

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00:18:07,360 –> 00:18:09,280
alternative strategy.

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00:18:09,280 –> 00:18:16,200
Buy what you need and spend the minimum amount that you require to be happy, focused, and

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00:18:16,200 –> 00:18:17,520
productive.

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00:18:17,520 –> 00:18:24,240
Take everything else and manage it wisely, which is out of scope for this episode.

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That’s a whole discipline all by itself.

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But trust me when I say that if you do that, you’ll sleep better at night knowing that

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you have assets that are growing and providing you with income and stability in the face

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00:18:37,600 –> 00:18:39,280
of uncertainty.

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00:18:39,280 –> 00:18:44,440
That’s something that you really can’t appreciate until you experience it, but I promise you

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00:18:44,440 –> 00:18:45,960
that it’s real.

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00:18:45,960 –> 00:18:52,760
We also hear a lot of this ancient principle of saving 10% of your income without exception.

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I actually read about this in the book, The Richest Man in Babylon, which is a great book.

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00:18:58,900 –> 00:19:02,960
You should read that or listen to it on YouTube if you can’t read.

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00:19:02,960 –> 00:19:07,640
For you Friends fans out there, this was actually the advice that Monica’s dad gave

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to her.

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00:19:08,640 –> 00:19:11,560
“10% of your paycheck, where does it go?

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In the bank.”

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00:19:12,560 –> 00:19:19,400
Now, obviously 10% is better than 0%, but this stuff really grinds our gears because

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what these gimmicks really do is they shut down the thinking process.

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For you, 10% may not even be close enough to meet your financial goals.

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00:19:30,040 –> 00:19:35,120
But when Monica’s dad tells you that this is what you should be doing, and you do it

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like a good little girl, where does that leave you?

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You’re screwed, but you don’t realize it because you’ve offloaded your responsibility to manage

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your finances onto this arbitrary rule.

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We don’t give any such rules to our clients.

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We help them develop a real financial plan that actually requires some thought and monitoring

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to help make sure that they’re on track.

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All right, so to start wrapping this up, here are our final thoughts.

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How much you can afford to spend is a highly personal matter that extends far beyond what

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your income is or how much cash you have in the bank.

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Let me give you some final points to consider.

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1. What you’re earning or spending today is only part of the equation.

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If you’re not adequately preparing for tomorrow’s challenges, how much cash flow you have today

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is highly misleading.

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2. I can tell you from personal experience in dealing with high spenders that your spending

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can have a detrimental impact on your relationships and those around you.

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3. When it comes to age, people have their spending habits backwards.

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The younger you are, the less you should be spending because you have time and compounding

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on your side and you have much longer to live.

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So think about that for a second.

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If you’re 95, yes, you can spend money like a drunken sailor because you probably don’t

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have much time left.

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If you’re 25, you’ve got millions of dollars in expenses in the pipeline heading your way,

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so you should act and plan accordingly.

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00:21:19,720 –> 00:21:25,040
Rather than listening to salesmen and financial gurus, you should be consulting with financial

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professionals to help you understand how your spending ties into your financial future.

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If you’re having a spending or budgeting problem, we’re here to help.

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00:21:36,360 –> 00:21:42,840
We help clients like you meet their financial goals in one-on-one consulting sessions.

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00:21:42,840 –> 00:21:48,040
If that sounds interesting to you, go to our website, biggerinsights.com, and fill out

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00:21:48,040 –> 00:21:52,760
the short form at the bottom of the page so we can schedule your initial consultation.

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00:21:52,760 –> 00:21:58,320
Otherwise, if you found this helpful, please consider making a contribution.

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We accept Monero (XMR), Bitcoin (BTC), and Litecoin (LTC).

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If your wallet supports OpenAlias, ours is contribute.biggerinsights.com.

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But if not, we’ll put a link to our Support Us page in the description.

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We used to put the wallet addresses directly in the description, but the Monero address

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is like a mile long and causes some text formatting issues, so we’ve removed them and we put them

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on our website instead, so you can go there and check that out if you’re interested.

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We are once again asking you to subscribe and share this podcast so that we can help

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as many people as we can.

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Thanks for staying until the end.

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Get your spending under control, stay healthy, and stay wealthy.

Blog

How Much Can You Afford to Spend?

This is a highly personal question and one that should definitely be discussed with your family and financial advisors. However, we can shed some light on how to go about determining how much you may want to be spending. How much you can or should be spending is largely based on your:

  1. Age
  2. Goals
  3. Income
  4. Assets
  5. Liabilities
  6. Family situation
  7. Health situation
  8. Risks
  9. Risk tolerance

Risks

Some of these are obvious, but others are often overlooked; leading to overspending. Take risks, for example – do you have the ability to absorb losses from being laid off, divorce, health issue, birth of an unexpected child, major home repair, or other setback? Do you and your spouse have life, health, car, home, accidental death and dismemberment, and disability insurance? Are your assets growing at a fast enough pace to provide the life you want in retirement? If not, you’re already spending more than you can afford because you’re all but guaranteed to encounter some of these. It’s more a question of when than if.

Goals

Goals are another common area of concern. We all want to be wealthy, which is a fine goal to have. But this is little more than a pipe dream if you don’t understand what saving and investing will be required to make that a reality. Let’s say you should be saving and investing $5,000 per month in order to meet your goals, but you’re only managing $2,000. How much can you afford to spend? Most would see that $2,000 and say “About $2,000”, which is why living paycheck-to-paycheck is so common. But the reality is you’re already spending way too much or earning too little. We would argue that you can afford -$3,000 per month and need to cut expenses and increase your income ASAP to fill the gap.

How You Make Money

Beyond your cash flow, you should also consider how you make money. You may have sufficient cash flow now, but that should be of little comfort if you hate your job, work long hours, or make the bulk of your money using skills that are soon to become obsolete. Do your best to determine how sustainable your income situation is before you blindly decide that everything is and will remain on-track.

"I Deserve It"

Many spend too much money because they work hard and “deserve” the nice things they buy. Being able to afford something is an issue of math, not one of your feelings. Whether you deserve something is immaterial if acquiring it comes at the cost of what you need or deserve in the future.

This is a trap that employees commonly fall into. Because they don’t understand the tax code and how this applies to different types of income (see The Three Types of Income), the harder they work, the more they pay in taxes. Their response to this is almost always to work harder. In a vain attempt to make their efforts feel worthwhile, they spend lavishly on homes, cars, boats, vacations, and other liabilities; only to find themselves needing to work harder to keep up.

Need vs. Afford

What you need and what you can afford are different things. At times, we may need things that we cannot afford, but that doesn’t mean you should ignore the fact that you’re spending more than you should or not earning enough to meet your needs. This sort of cognitive dissonance is common among those who live in an expensive area. The logic goes “Well, my rent is 50% of my income, but I need a place to live, so there’s nothing I can do about that. I can’t get ahead because of greedy landlords.” It’s true that you need a place to live, but there’s always something you can do to take control of your financial future:

  1. Can you find a way to make more money?
  2. Can you move to a cheaper area?
  3. Are there expenses you can cut?
  4. Can you move in with your parents, grandparents, or friends?
  5. Can you do work for your landlord in exchange for lower rent?

Needs are often subjective – do you really need:

  1. A platinum limited edition 7-seater to transport your only child?
  2. All of your kids to have separate bedrooms?
  3. To fund your child’s college education?
  4. To buy a new cell phone every 1 to 2 years?
  5. A $2,000 laptop to check email and social media?

Of course, wealth doesn’t typically come to those with a scarcity mindset. However, being wasteful when you’re trying to get ahead isn’t wise either. If you start thinking about what your goals are, and what you need to do in order to achieve them, you will likely find that what you thought you needed is not actually the case.

Allowing Salesmen to Tell You What You Need or How Much You Can Afford

A salesman’s job is to sell. It’s your job to make sure that what you’re doing is in your best interest. This is obvious, but we see people spend too much money on homes, cars, etc. because they took the advice of the person selling to them. A salesman will tell you things such as:

  1. “Based on your income, your home should be about $450,000”
  2. “You can afford this $50,000 car”
  3. “If you’re having trouble coming up with the down payment, take a loan out on your 401(k)”
  4. “The engagement ring should be 20% of your annual salary”

These are bold and irresponsible statements that may be horrible advice depending on your situation. Below are some tips to help you avoid falling into these traps.

Before You Shop

Before you go shopping, establish and stick to a set of requirements for what you need as well as a budget. This will empower you to remain objective and stick to your plan. If new information comes to light, take time to think about it before making a rash decision. This may require sleeping on it.

Know the Salesmen

Understand who the salesmen are. Many will not have “Sales” in their title, but pretty much anyone you talk to who will help you spend money is a salesman. Warren Buffett summarized this quite well by stating, “Never ask an insurance salesman if you need insurance.” This includes insurance agents, real estate agents, mortgage brokers, bankers, and occasionally shady professionals that are supposed to be looking out for your best interests – e.g.:

  1. Your attorney may recommend services or strategies that aren’t appropriate for your situation
  2. Your doctor may recommend procedures, tests, devices, or medications that you don’t really need

Spending as a Percentage of Your Income

Looking at spending as a fixed percentage of your income is a recipe for living paycheck-to-paycheck. Salesmen and financial gurus love talking about saving and spending as a fixed percentage of your income, but this is dubious because there are many other factors to consider than just your income. For you, spending 30% of your income on housing may make sense. For your neighbor who is making the same amount, 30% may be way too much.

One obvious flaw in this logic is that this may encourage you to spend more than you otherwise would. Perhaps you and your spouse would be happy living in a home that costs only 20% of your income. However, when the financial gurus say your housing should be 30% of your income, this will translate to “we should buy a nicer home” for many.

We often hear that you should save 10% of your income. Why 10%? On what logic is 10% the right number for you? Depending on your situation, maybe you should be saving and investing 50%, so if you’re saving 10%, where does that leave you? 10% is a small number, especially after inflation takes its toll.

Personally, we hate hearing these rules of thumb because we see that they shut down the thinking process for those who are most in need of thinking critically about their financial situation. “The lady at the bank said we can afford it, so we should be good.” No! The lady at the bank’s only concern is whether you’re going to make the payments! Is she going to be there for you when you’re washing dishes for a living at age 70 because you spent too much money? Of course not.

Final Thoughts

How much you can afford to spend is a highly personal matter that extends far beyond what your income is. Rather than listening to salesmen and financial gurus, you should be consulting with financial professionals to help you understand how your spending ties into your financial future.

Understand that:

  1. What you’re earning and spending today is only part of the equation. If you’re not adequately preparing for tomorrow’s challenges, how much cash flow you have today is highly misleading.
  2. Your spending can have a major impact on those around you, as well as a source of strain in your relationships
  3. The younger you are, the less you should be spending because:
    1. This better allows you to take advantage of the power of compounding
    2. The younger you are, the greater your expenses are expected to be between now and when you die

If you’re having a spending or budgeting problem, we’re here to help. We help clients like you meet their financial goals in one-on-one consulting sessions. If that sounds interesting to you, fill out the short form at the bottom of the page so we can schedule your initial consultation.

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