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6 Ways to Understanding the True Costs of Your Stuff

680711_makin_changeSaving money is critical to achieving financial independence. As I’ve mentioned before, I’m not particularly fond of extreme frugality.  I’ve also mentioned that I prefer to make thoughtful decisions about everything that I’m going to purchase.  One of the factors that goes into that decision is how much I feel that a given purchase will improve my life.  The other factor is how much it costs.  Have you ever wondered how much something costs?  Probably not, because it’s usually right there on the label.  But there are many, many ways to determine the “true” cost of a purchase.  They all have their strengths and weaknesses, but the more aware you become of just how much something is costing you, the more thought you’ll put into every purchase.

1. Sticker price

It all starts here.  This is probably the simplest way to think about the price of something, and the way that we are all familiar with.  How much does it cost?  It says $10 on the price tag, so it costs $10.  Okay, $10 plus tax.  That was simple.

 

2. Total yearly cost of a recurring expense

Coffee, purchased from Starbucks, is the most commonly used example of this.  I will admit to loving my coffee and to having ran head first into this exact situation.  I did the math and immediately switched to making my coffee at home.  Here’s how to approach the cost.

Let’s say that you buy a nice mocha for $4.00 every day (Mon-Fri) at your local coffee hole (*).  $4 is chump change for most people.  So we gladly part with it.  The problem isn’t that you’re spending $4 on coffee, everyone deserves to splurge on themselves every now and then.  The problem is that you’re spending $4 a day, five days a week on coffee.

$4/day X 5 = $20/week

$20/week X 4 = $80/month

$80/month X 12 = $960/year.  Holy crap!

However, this can be applied to other things.  Let’s take my internet bill of $60/month.  It’s good to be a monopoly.

$60/month x 12 = $720/year.

Holy shit!  I was actually spending more money on coffee during my grad school days in a low cost of living city than I am on internet service in a high cost of living city several years later.

Needless to say, I now make all my own coffee at home.

 

3. Cost to sustain in financial independence

Since this blog is all about financial independence, it’s always good to know how much money you need to have in the bank in order to finance any given recurring expense.

Let’s assume that your portfolio throws off an average of 3% in dividends per year.  Multiply the yearly cost by 33 to get an estimate of how much money you need to have in your brokerage account to sustain any given expense for the rest of your life.

Sticking with our coffee and internet examples:

Coffee: $960/year x 33 = $31,680

Internet: $720/year x 33 = $23,760

Wow!  Is a daily mocha at Starbucks really worth $31,680?  Maybe it is, and maybe it isn’t (my vote is no).  The point of this example is to drive home just how hard both you and your investments are going to have to work to pay for any given expense.

 

4. Opportunity cost (or what that money could have been doing instead)

Back to our coffee example. I refuse to give up my coffee, so I try to make it at home.  I go to the store and buy one of those big 2 pound containers of coffee and make my own.  I  buy some milk as well.  So let’s just say that the whole expense runs me $15 per month.  $15 x 12 = $180/year for homemade coffee.

Money saved by making my coffee at home: $960 – $180 = $780/year.

What would I do with $780?  Put it into my investment account, of course.  Compound interest time!

Let’s assume that by reducing our coffee expenses we have freed up $780/year.  We’ll also assume that our investments net an 8% per year total return (capital gains plus reinvested dividends).  Finally, we’ll assume that we do this for 10 years.  That’s $12,203.48 more towards financial independence.

You can easily compute this for yourself by using a compound interest calculator.

 

5. Total cost of ownership

This is probably best applied to cars, but can be applied to anything else that requires maintenance and upkeep.  I spent ~$6,000 for my very used car (with license plate and registration included).  But my car expenses haven’t ended there.  Insurance runs me about $1,000 a year.  Maintenance work, another $1,500 per year. Fuel, probably around $1,300 per year.

So my total cost of ownership isn’t just the $6,000 I spent on the vehicle.  It also include almost $4,000 per year in upkeep.  Which if we remember the previous example, requires about $132,000 in my portfolio in order to sustain this expense.  Given that no car equals no freedom, I consider this an acceptable expense.

 

6. Cost per use

I drive my car about 6 days out of 7, or 312 days per year.  Probably a bit more.  Based on the $4,000/year operating cost, my car is costing me an average of $12.82 per use.  On the other hand, that $6,000 initial expense is down to about $3.20 per use and will continue to drop as long as I keep the car.

How about another example.  I buy a shirt for $25. If I only wear it once, that’s $25 per use.  If I wear it 25 times, then it’s only costing me $1 per use.

If you buy a high quality item, use it regularly, and keep it for life, the cost per use drops to near zero.  On the other hand, if you buy low quality items that continually break and need to be replaced, your cost per use will remain much higher.

(*) My hunch is that coffee is more expensive these days, but I’m too lazy to go and check.

 

Readers:  How do you think about your purchases?  Do you use different methods for different products?

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28 Responses to "6 Ways to Understanding the True Costs of Your Stuff"

  1. I’m not into extreme frugality, although my savings rate begs to differ. I’m pretty minimalist naturally so it just works out that way. Too many people will sit there and complain about money, but it just takes a few simple switches to make real change and improve your situation. I really like to compare things to their cost to sustain in financial independence. $90 per month cell phone bill, well that’s normal. That ends up being $36,000 needed in your account to pay for it.

    1. MFIJ says:

      You’re right about the switches. Some people lampoon the idea of the latte factor, but gourmet coffee soaked up a lot of my grad student stipend. Eating out is another big killer. So was running my air conditioning in one apartment that I lived in. And the list goes on. $10-20 a month here and there adds up. Not only across different spending categories but also across time.

      Now my biggest problem is that I run the risk of wandering into the territory of being too cheap and needing to live a little.

      1. greg says:

        “Now my biggest problem is that I run the risk of wandering into the territory of being too cheap and needing to live a little.” – I see you’re still strongly conditioned by a consumption-oriented society =P

        1. MFIJ says:

          I’ve never declared myself to be an anti-consumer. Nor do I want to be. The life of an ascetic isn’t for me. I like stuff. I like the benefits that stuff provides me. It’s only because my capital is finite that I am forced to strike a balance between consuming and saving.

  2. We’re fairly similar, especially in looking at the annual cost. We love coffee as well, but a grand a year can be used on much better things and make it at home.

    1. MFIJ says:

      While the coffee seems innocuous, it’s a killer when you’re living on a grad student budget. Coffee was actually one of the first things to get the ax after I started tracking my spending.

  3. Eric says:

    This is a great look at the cost of your stuff. We often just look at the price when we buy it and don’t think of the long-term, recurring costs of ownership. I look at that all the time at work, but rarely at home.

    1. MFIJ says:

      Eric,

      Thanks for stopping by.

      I’ve often just looked at the price of things. But as I’ve gotten older, I’ve started incorporating additional ways of looking at the cost of goods. Sometimes this has proved insightful. Sometimes not.

  4. Integrator says:

    I also tend not to evaluate costs for items on a lifelong or yearly basis for things. My approach to frugality is normally whether I get use from the item or not. If its something that I do get use for or value highly, I tend not to think to much about it. If I don’t get good use from it then it gets cut.

    1. MFIJ says:

      I get a little closer to your line of thinking every time I move. I should have added “would I lug it across the country” to my list. At this point, anything that doesn’t satisfy that requirement isn’t getting bought.

  5. Great post and points! People believe investing is so hard when over half the battle is in relation to your savings rate. Unfortunately the majority of our society has subscribed to this “YOLO” (You only live once) methodology and has convinced themselves they deserve all these little daily expenses.

    1. MFIJ says:

      I’m actually a bit sympathetic to the YOLO crowd, particularly as I get older and see the grim shadow of death getting ever closer. But I don’t think that YOLO and fiscal responsibility are mutually exclusive. I try to set aside money for fun and I always pay myself first.

      And if my math is right, I will be able to YOLO (can I use this as a verb?) every day off of my passive income when I finally hit financial independence. Not bad when most retirees are going to be downsizing and pondering staycations.

  6. Justin says:

    With certain products, I tend to think of what will be the best long-term outcome. For example, if I had a choice between two items, one cheaper and one more expensive and better quality. I’ll debate if, over the long-term, I might save more money buying the better quality item. Why?
    Because I may have to buy the cheaper item more often than if I bought the more expensive one once.

    1. MFIJ says:

      I will usually buy a more expensive product over a cheaper one if it will last longer. The one good example of this that I have is shoes. I used to buy generally cheap shoes and had to buy a new pair every year. I bought one good pair of shoes and it’s lasted me four years now. I did have to get it re-soled, but still I saved a lot of money by spending a more money on one good product, than buying the same cheap product over and over again.

  7. Martin says:

    yeap, these little pennies add up quickly. Sometimes I have a feeling that my spending compounding is faster than my investment compounding income, which makes me crazy. So I am cutting corners wherever I can.

    1. MFIJ says:

      The size of a “little” expense is also relative to your total income. Today, I could probably buy all the expensive lattes that I want and still hit my savings goals. But when I was in grad school, making much much less, those little expenses were a killer and made the difference between breaking even and dipping into my meager savings.

  8. LOVE this, especially #3!!! It’s so easy to forget that the sticker price isn’t the ONLY price of what we buy. Thanks for a great article!

  9. Mrs. 1500 says:

    When Mr. 1500 and I first started thinking about a blog, we decided to track our spending. Every purchase, on a piece of paper with date, where, what and how much. We did this in November, and there were many once-a-year purchases (Thanksgiving Dinner supplies, etc.) so we did it again in December. Again, more once-a-years like Christmas gifts and travel expenses.

    Now, we keep track of all expenses on two pages, one page for those one-time-only deals, and the other for regular monthly expenses.

    That first month, it is pretty amazing to see how much is being spent on things you don’t really need. Since doing that in November, everything I buy is thought about, first. Do I need it or do I want it? Most importantly, will I use it? Many things get put back on the shelf.

    Thanks for a great post!

    1. MFIJ says:

      I track my expenses religiously in Excel. This is great because I always know where my money is going. It’s also bad because it contributes to me overthinking every purchase. After having had to move several times over the last few years for training and career purposes, I would add “Am I willing to lug it across the country?” to the list of questions I ask myself before buying something.

  10. I think it’s important to find the annual cost of recurring use because it helps put things in perspective once you multiply the relevant figures. It’s just like if you save $5 each day (which seems ever so menial) you end up with over $1,500 after one year (which seems a big fat amount you can use for absolutely anything).

    1. MFIJ says:

      Thanks for stopping by!

      Annual costs really amazed me when I started calculating how much I spent on coffee and lunch. Now I make my coffee at home and I make my lunch at home too. I would much rather have all those hundreds of dollars invested, or at least spent on something other than overpriced coffee and mediocre cafeteria food.

  11. Jim says:

    Great post MFIJ, love #4, I think people never take this into consideration. There are opportunity cost in everything we do, many people do not realize this. Thanks for bringing it to people’s attention!

    1. MFIJ says:

      When I was in graduate school, I made a pittance of a stipend. Now, even though I make a nice wage, I’m trying to save an excessive amount of it. Being in these kinds of situations really forces me to think about opportunity cost. I only have so much money that I an spend, so I need to be very careful that what I’m spending it on is the best choice out of all the options.

  12. Manefla says:

    Hi MFIJ, I think you missed an important point. In my view, the crittical issue is that we, the people, buy all the stuff with the money we get after paying taxes.

    So, for me, the price on the sticker must be increased by your income taxes.

    Keep the good job.

    Very truly,

    1. MFIJ says:

      Manefla,

      Thanks for stopping by! That’s a great point too. It’s really interesting conceptually because the price would actually vary based on how much income you make and what kind of income it is. So prices would be higher for me if I made wage income than if I made qualified income from dividends. And prices would be higher for me now that I have a higher paying job than they would be when I was in grad school.

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