Tag: planning

Rent or Buy

Several years ago, I realized that I could save money if I stopped paying for services and equipment that wasn’t necessary. An example of this is the local service provider was charging $10.99 per month for the use of a Wi-Fi router. After doing some research, I learned that I could buy a comparable Wi-Fi router for about $99.00, which I did. Forty months and two moves later I am still using the same router. I think that was a reasonably good investment, but let’s look at the numbers.

This is a good place to look at the return on investment (ROI). Return on investment in this case is a calculation the indicates how long it takes, in months (or payments) into recover the original investment. The investment was $99.00 to purchase a Wi-Fi router. The rental price was $10.99 per month to use the service provider’s Wi-Fi router. Therefore, the ROI calculation $99/$10.99 = 9 months. That is a great ROI.

The investment also generated a monthly saving of $10.99 + taxes but let’s ignore the tax. The savings generated by purchasing and using the router are the number of months times the cost per month less the investment (40 months x $10.99 monthly rental – $99 investment). The savings to date has been $340.60. Which is not bad for a simple investment such as this.

The ROI calculation is a great tool to use when trying to decide between options. You always want to go with the option which has the best ROI. In this situation the options were to rent the router or own the router. Because there was a high probability of using the router for more than nine months, it was logical to make the investment to own the router. Had the usage duration been less than the nine months it would have been better to rent the router.

There are other money savings options in our daily lives which we should consider. Take some time and look for one or two. It might not seem like a lot of money initially, but over time, all those little numbers add up to one really big number.

Asset or Liability

One of the most recent concepts that I have to considered  is deciding whether whether to classify something as an asset or a liability. For example, what is a house, an asset or liability? I think that is a good question to ask and clarify.

 

My understanding is that according to Robert Kiyosaki, author of Rich Dad Poor Dad, an asset is anything that makes money or produces revenue and a liability is anything that costs money. So what is a house? Based on the definition above, a house can be either an asset or a liability. If you rent the house or use it for business purposes therefore it generates revenue, then the house is an asset. However, if the house is a residence and lived in and has a mortgage payment, then it is an expense and therefore a liability.

 

It might be a difficult concept to grasp, because we are often told that a house is an asset. And in a sense it is, because it is worth money when it is sold. When a mortgage is issued on the house, the property is then owned by the mortgage company and the occupant is paying rent or what is often referred to as a note. Therefore the house is an asset to the mortgage company, because it is generating revenue; and a liability to the occupant, because it is an expense and the occupants are making a payment.

 

What about if there is no mortgage on the house? Same rules apply, if the house generates revenue it is an asset, if not it is a liability. Again, for the occupant the house is a liability because of the expenses associated with living in the house. If the occupant is a renter, then the renter makes a payment to the owner. For the owner the house is an asset, it generates revenue; and for the renter the house is a liability, it is an expense. If the owner lives in the house, then the house is a liability because it does not generate revenue. This is because the house only creates expenses for the owner in the form of insurance, taxes, and maintenance costs.

 

Using the definition above it is simple to determine if something is an asset or a liability. If the investment generates revenue, it is an asset; if not, it is a liability.

Sunk cost

I have noticed that we frequently let past decisions keep us from future opportunities. Let me explain what I mean by that statement. We worry too much about the ‘sunk cost’. A sunk cost is when you have already spent time or money, which can never be recovered, on something. I like to include them in the definition of sunk cost, primarily because time is a resource that once spent is gone forever.

An example of a sunk cost is you bought a season pass to a swimming pool. You can never recover the money spent on the pass, all you can do is utilize it to maximize your enjoyment. The money is gone, regardless of how often the pass is used.

One of the most common statements I hear goes something like, “We spent $xxx to do ____, so we cannot do ____.” Now if you fill in the blanks the statement might be, “I spent $10,000 on the car, it is now worth $7,000, so I cannot sell the car because I cannot get what I paid for it.” This is the sunk cost syndrome. We might be clouding our decision making by hanging on to the sunk cost. Maybe the outlook needs to change too, “I can get $7,000 if I sell the card today.” The idea is to not worry about what you spent but to focus on what you need to do moving forward. Another way to view this is to ask, would you make the same decision today?

Sunk cost syndrome creates a situation where we are hesitant to change direction or consider alternatives that had we not worried about the past decision the choice would be simple as well as different. I would suggest that when considering options try to avoid the sunk cost trap and don’t let past, unreversable costs stop what you have planned for the future.

Make a decision

Sometimes we spend too much time waffling back and forth about a decision. This is generally referred to as procrastinating. And often we view it negatively. Sometimes it can be good to take time to make a decision, while other times it is best to just decide and move forward. Now let’s consider a when it is good to take time to make a decision, when it is good to be quick and what might help speed things up in the decision making process.

Slow decision time….

It is often good to take time to make decision which have long lasting impacts on you and your family. This might be decisions about buying a new car, making a career change, having children or moving to a new neighborhood and possibly which school to attend. Basically, these are all items which are difficult to reverse or undue. This is when it is good to take a deep breath and evaluate what it is you really want or need. Try to keep the emotion out of the equation. An example is buying a new car. Often there is pressure from others to do that and the reasons all seem legitimate…at the time. But really the only thing most of us need is a car good enough to get from point A to point B. In my situation, that is about 15 miles one way. I don’t need a fancy car to do that. I do however need a reliable car. The difference is the cost.

Quick decision time….

At times it is good to make quick decisions. Like what to have for lunch, or simply deciding not to eat at a restaurant. Deciding how much to put in savings each paycheck. Quick decisions usually have little or no impact on our overall quality of life (yes, I am excluding catastrophic or major emergency situations). These decisions are simple and leave us feeling generally good.

Decisions made easy…

What makes it easy to make decisions? When you know what you need or want and the difference; the decision making process becomes really simple. Going back to the car scenario, if you know what you need and your budget, then you have naturally limited the choices. So, we could say that in order to help the decision making process simple then we should find an easy method to limit the choices. There are three things to consider in the decision making process: values, cost, and does it help me achieve my long range goals? Every decision should be guided by those three considerations. Cost is a twofold scenario of economic or monetary and social. Remember that there could be a social cost associated with a decision. For example are you willing to risk public ridicule for your decision?

Establish your value, which means what you, as a person, are willing to allow in your world. You have direct control over this. You don’t have to buy that car, take that job, or eat that food if you don’t want to. Second always establishes a budget, what you are willing to spend or what the pay at a new job must be. Third, make sure it moves you toward your long term goal. If your goal is to be a millionaire, then buying fast food at every meal probably won’t help you get there very fast.

When you have established these three things you will become very focused and intentional about how you make your decision. Give it a try. Write it down and see how it works for you.

Milestones

One of the most important elements of setting and achieving long-term goals and objectives is to celebrate milestones. A milestone is the achievement of an intermediate goal or objective. For instance, if the goal is to lose 30 pounds in a year a milestone might be losing 10 pounds. Now, we celebrate all kinds of milestones in our lives some are quick and easy, while others take years to achieve. Examples of quick and easy milestones are birthdays or anniversaries. We celebrate these out of tradition and without much thought.

Let’s explore what we could be celebrating as milestones if the goal much higher and make it a bit more complex. Something like saving for retirement or getting out of debt or starting a new business. All of which I am trying to do. I must admit that it is better to focus on one thing at a time. Like getting out of debt and letting retirement go to the debt is cleaned up. However, I have chosen to do all three at simultaneously, which is not bad just not the best. The reason is that what is going into retirement could be going to the debt which has a guaranteed ROI (example: 4% on the car loan, 5.25% on the motorcycle loan).

Back to the milestones. In most instances there are intermediate achievements within the larger goals that should be celebrated. These little celebrations will provide some added motivation and something to look ahead to in the drive to achieve a larger goal. An example might be, if the larger goal is to become debt free a milestone would be to reduce the debt by 20%. Or maybe the larger goal is to become a millionaire, a milestone might be when you have $100,000.

The idea here is to keep the momentum and energy up. If you have never celebrated a small victory, then you might lose sight of what is important. Celebrating the achievements and progress is very important.