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How You Can Know Whether You Can Afford It

Determining whether you can afford to buy something, be it a new house, new car, clothes, vacation, and so forth can be tricky. The purpose of this post is to define Affordability.
The first thing to understand is that you can have anything you want, you just can’t have everything you want!  You will always have more opportunity to spend money than you will have money to spend.  What this means is that we all have limits to our available dollars and we need to work within those limits.  Buying at discount is good, but is not enough reason to say that you can afford a new purchase.  The discount may make you feel good but discounts don’t justify the purchase from an affordability standpoint.  Just because you have money in the bank, or are expecting next week’s paycheck, or you have an available credit card, orcreditcard can make monthly payments, does not mean you can automatically justify a purchase.
For purposes of defining Affordability, let’s assume that we are talking about purchases of $200 and up.  These we would call major purchases. Whether you are paying for the purchase in total, or paying over time, it is the same.
The decision to buy based on affordability is made up of 2 major factors:

  1. Opportunity Cost.   All expenditures come at a cost.  This means that you only get to spend a piece of money once.  If you choose to spend a dollar in one place, you will no longer have it to spend in another.  Of course you can replace that dollar, but you will still have one dollar, whereas you could have had two.
  2. Long-term Financial Goals.  If you can achieve your personal long-term financial goals and spend money in any instance too, then you can “afford” it. Remember, in the absence of long-term financial goals, you will make financial decisions you cannot afford!  For example, you might decide to buy an extra car today at a cost of $20,000.  You have the means to purchase the car and it seems harmless enough, right?  Maybe not.  Without looking at the big picture and your long-term goals, you might not see that you truly cannot afford the extravagance.  It will rob you of interest earnings for retirement.  A time value of money (TVM) calculation will show you that the purchase of the car will actually cost you $100,000 plus, and then all you have to show for it are depreciated, dilapidated, worn out car(s).

For answers to your questions about what you can and cannot afford in terms of retirement planning, contact me: 801-292-1099, alan@moneymastery.com.

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