Spend or invest? New thoughts on an age-old dilemma
A familiar experience for many Americans is that as fast as money comes in, it goes out the door again in pursuit of the next “must have” purchase. Such spending habits can take a toll on plans to build up savings for the future. The key is finding a balance between immediate gratification and long-term financial security.
In many instances, we can all find ways save on daily purchases to set more money aside to help meet goals like saving for retirement or a child’s education. The bigger challenge comes when it is time to make a major purchase – a home, a car, appliances or home improvements. These expenditures can require the immediate outlay of thousands of dollars. You may have to drain money from savings or at the very least reduce available funds to invest for your future. When is the expenditure worth it, and when is the cost too prohibitive relative to your financial future?
Judging the “real” cost
There are a variety of ways to assess the financial value of a major purchase. The approach you choose can vary depending on the type of expenditure you make. Here are three ways to think about it:
- Opportunity cost
Whenever you’re making a significant purchase on a product or service, you need to look at how it will impact your financial future. It is important to assess the opportunity cost of making a cash purchase today. For example, consider what could happen if instead of spending $5,000 on a home entertainment center, that money was invested for 20 years earning 7% per year. Over time, that $5,000 could grow to more than $19,000 (not accounting for taxes or investment fees). Assessing potential opportunity cost is one way to better evaluate the real cost of making a significant purchase.
- A “return on investment”
Another consideration is whether there is a payback on the purchase. For example, paying for a class or a college degree may provide a future return in the form of the potential for increased income. Anybody who has spent (or taken loans for) $100,000 or more for a medical or law degree likely does so with a reasonable expectation that future income will more than make up the difference. A home improvement may be looked at in the same way – an investment that may be recouped in the future.
- Borrowing the money to cover purchase costs
While it may be tempting to pay for purchases with credit cards, home equity loans or other types of financing, you have to think about how much borrowing the money will cost in the long run. The key here is to limit interest charges as much as possible. It’s not that you necessarily need to avoid all debt. In some instances you can incur “good debt,” which is used to purchase an asset that has a long lifespan, increasing value and other potential benefits such as tax deductibility of interest. Mortgages and student loans are typically considered good debt.
Major expenditures aren’t just about the immediate benefit. You should consider whether the current cost would become more significant over time because the money was not invested for your future.
Thomas A. Callaway CRPC®, is a Financial Advisor with Ameriprise Financial Services, Inc. in Paris TX. He specializes in fee-based financial planning and asset management strategies and has been in practice for 21 years. To contact him you can go to www.ameripriseadvisors.com/thomas.callaway or call (903)785-7000, office located at 2219 Lamar Ave Paris TX 75460.
Ameriprise Financial Services, Inc. Member FINRA and SIPC.
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