Tag: spending

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.