Focus on What's Important

You have heard it before from many 'experts' on TV and Internet - if you can skip the $4 Starbucks latte in the morning, you will have a lot of money at 65. That advice, though popular, is not realistic and leads to a "penny wise, pound foolish" mentality.

If you really want to take charge of your finances in your personal life, focus on the top 5 things that cost a lot which, many don't even care to think about. Even if you did, most of us are programmed to buy into the 'better-quality-of-life' myth perpetrated by the marketing whizzes on Madison Avenue. Here are the top 5 important expenses for most working people:

1. Housing costs (rent or mortgage)
2. Car
3. Insurance (all types)
4. Major Discretionary Purchases (such upgrading perfectly good appliances, furniture, clothes etc.)
5. Discretionary Subscriptions (anything that comes with a monthly bill...starting from cable TV all the up to spa or upscale club memberships)

Note that I have not included your morning latte or your $5 daily lunches. I have not even included vacations or any occasional splurges that we as humans do to make life interesting. Why? Because I believe in the 80:20 rule, which in this case means that if you are careful about the top 5 expenses I mentioned above, 80% of your money problem will be solved!

That's right. Most people live paycheck-to-paycheck because they are not able to control these top 5 expenses. They buy a house beyond their means, buy a new car every 4 years and pay high insurance costs on both, buy top-of-the-line appliances and furniture (often on credit, causing monthly bills that stack up) and to top it all, sign up for 'monthly extras' (gotta have a membership to this club or that league or this spa to match your house and car, right?).

Before they know it, they are in debt upto their eyeballs and when they wonder how to manage, they are told to give up their $4 latte, 'cos a cup a coffee is available for $1 or less at a gas station. You know what, Starbucks makes one hell of a cup of coffee for $4, and I have not found the $1 coffee at any other place taste nearly the same! Enjoying an exceptionally brewed cup of coffee is one of life's few indulgences affordable to many. It is actually a good return-on-investment (ROI)! What is a lousy ROI is buying a brand new Cadillac to drive a high-traffic, pothole-laden road for 30-45 min. each morning to work, when a 4 year old Honda can do the same thing (and probably more reliably over the next 5 years). The price differential is about $25,000 between the two cars, and the finance cost differential (FinGho Walkers can buy the Honda with cash) will add up to $7,000 or more over 5 years, and the insurance cost differential between the two cars will add up to $1500 per year or $7,500 over 5 years. I am not even considering the price differential in repairs - fixing a dent on a cadillac will cost you a whole lot more than a Honda. For a detailed analysis, see Latte-nomics vs. FinGho-nomics.

In effect, the Cadillac-buyer will have spent about $40,000 more than the Honda buyer over 5 years (actually a lot more, if you consider the opportunity cost of money - we will cover that later). This difference, ironically enough, can allow the Honda buyer to also buy a Cadillac after 5 years just for kicks (though FinGho Walkers would never do that) and have money left over, compared to the original Cadillac buyer who now has a 5 year-old car. If the Honda buyer also practices the FinGho Walker principles, he would have more than $55,000 at the end of 5 years. This is the "opportunity cost" - that is the cost of putting your money to work somewhere else instead of making this purchase. So, the Cadillac buyer 'lost' an additional $55,000 to buy his car compared to our FinGho Walker friend who settled for a 4-year old Honda and yet, both have a good enough vehicle to drive to work and back. Talk about a lousy purchase! By my definition, any purchase that has a high opportunity cost is a lousy one.

Same thing applies for house purchase. What? Wait a minute...house is an 'appreciating' asset, car is just 'depreciating' asset, some among you will argue. True, you can't compare one with the other, but the mentality of stretching beyond one's means applies nonetheless. The housing issue is so contentious that I decided to write about it in a separate blog. Stay tuned...

RV