“Where the heck is all my money going?!” No, that’s not the question that changed my entire mindset around money, but it’s the question that led me to examine my shopping habits and put a stop to uncontrollable overspending, once and for all!
It’s no secret that spending all your money is not the key to building wealth or Living a Life You Love. But I bet you didn’t think that the main difference in people who can’t stop themselves from buying and those who can is all in the way they think!
This article is going to help you learn how to immediately dull the temptation you feel when you want to make a purchase, teach you how to ask yourself hard questions about how you’re using your money, and hopefully give you a new perspective that will help you stop overspending (like it did for me)! Ready to FIRE YOURSELF?
That’s it. That’s the question that single-handedly taught me to reconsider before opening my wallet. I started forcing myself to calculate the TRUE COST of EVERY PURCHASE. If you don’t know what the heck I’m talking about, don’t worry. I’m going to break it down for you.
I recently read Procrastinate on Purpose: 5 Permissions to Multiply Your Time by Rory Vaden. In his chapter on Automation, he tells a perfect story to illustrate what I mean by calculating the true cost of a purchase. I’m going to paraphrase it here, but you really should check it out for yourself.
For this story, there are three kinds of people – those who will never have wealth (and may even have debt), those who will only ever have moderate wealth, and those who will become wealthy. All three of those people walk into a coffee shop, and they each consider buying a $5 latte. But here’s the thing – how they each consider the purchase looks completely different.
This person will do anything to get what they desire! Hence the reason so many people borrow money and the reason so much of the world is knee-deep in credit card debt. These kinds of people have a really hard time saying “no” to their compulsive selves.
I was this kind of person not too long ago – spending my free time wandering the aisles of stores, constantly adding things to my online shopping carts, doing anything to get that dopamine rush of acquiring an item I wanted. These kinds of people will never build wealth if they never decide it’s time to change the way they view money… until they’re ready to FIRE THEIR “OLD SELVES” to make room for growth.
This type of person is in a better situation because their first instinct isn’t to borrow money they don’t have in order to satisfy a fleeting want. However, if we all go through life spending money just because we have it, it will be near impossible to build substantial wealth! Over time, by saying “no” to some larger purchases, this type of person may create a little bit of financial stability, but by no means will they ever be able to be financially independent (and they definitely won’t retire early).
The wealthy person asks the same first question as everyone else, and they don’t deny the fact that they do want the coffee. However, they understand that just wanting something does not justify making a purchase. Desire is a fleeting feeling that should not be grounds for decision-making! Once this type of person realizes they want something, they then go on to weigh the true cost of it, which will help them decide how much they want it.
So how does this help you stop overspending? Well, you need to learn to pause and calculate the true cost of pretty much everything you want to buy. Let me teach you!
The true cost of something is made up of a million things, but for the purposes of this article, we’re going to focus on the four monetary aspects of true cost:
For starters, the actual cost is the physical cost of an item at the time you purchase it. In our coffee shop example, the actual cost was the $5 price of the latte! This component of true cost is pretty straightforward. What’s the price tag say?
Opportunity cost is based on the idea that once you use an amount of money to purchase something, like the $5 cost of the coffee in the story, all other opportunities to use that money vanish! By saying “yes” to a purchase, you’re inherently saying “no” to all other potential uses of that money. So, in our example, the opportunity cost of the $5 coffee is also $5 – those dollars no longer have the chance to do anything for you since they got you that coffee.
What kind of opportunities does $5 have? Plenty! For starters, you could set it aside and save up for an online course or training in an area you’re passionate about. You could save up to start a new business. You could save it for a rainy day. You could donate it to a charity of your choice and help others.
All of that is good and well, but some days coffee sounds better than a startup or a bit of philanthropy. What other opportunities are you turning down when you trade your hard-earned money? The opportunity to invest it into the stock market. And to really understand why that opportunity is so incredible, we’ve got to move on to “Hidden Cost.”
So, let’s talk about the real reason to understand opportunity cost – the hidden costs that you give up when you close the door to all those opportunities! Hidden Cost (as Rory Vaden calls it) is the “extrapolation of potential additional benefits or costs associated with a certain opportunity.” The most substantial opportunity you’re giving up each time you make a purchase is that money’s opportunity to earn compound interest in the market over time.
Let’s use the $5 coffee as an example, again. The person who will undoubtedly become wealthy contemplates, “What will this really cost me?” They begin to calculate the opportunity cost of $5 that, if they don’t spend it on coffee, could sit in the market for 30 years and earn an average of 7% interest each year! In 30 years, at that rate, that $5 would be worth $38.06!!! (Sheesh! That’s an expensive cup of coffee.) This means that the hidden cost of that $5 cup of coffee is $33.06.
Don’t worry, I don’t do that math in my head any time I’m thinking about buying something. I’ve got a really useful tool for you! Meet the Investor.gov U.S. Securities and Exchange Commission Compound Interest Calculator. (Do yourself a favor and bookmark this bad boy on every device you own.)
If you want to figure out what a one-time purchase would grow to be in a set amount of time, you:
I use this tool alllllllllll the time. Seriously, the number of times I’ve been standing in line to make a purchase and then put the item down on a random shelf and walked away or just completely cleared out my amazon cart, thanks to this calculator, is mind-boggling.
Being able to quickly see the opportunity that your money would have if you’d invest it in the market is exciting. Way more exciting than paying $5 (or really, $35) for a coffee!!! But opportunity cost isn’t the only thing you’re giving up when you buy something.
One other helpful thing to think about when you ask yourself “What will this really cost me?” is how much it took you to earn the money you’re spending. A $5 coffee may be a bit too small of an example for this method to have a big impact, so I’ll tell you a story.
A few months ago, I had to go to Best Buy to get a gift – my mom wanted an Instant Pot for her birthday. While I was in there, I wandered down the aisles just because I’d made the trek over there. I came across the iPhone 12 mini, and suddenly I wanted it so bad.
I love smaller phones, and Apple hasn’t made a mini in years! My brain erupted in a frenzy of justification… a smaller phone would make my life so much better… if I upgrade now, I won’t have to again for another 4 or 5 years… this phone would be so much easier to hold while running… texting… talking on the phone… I could have sold this thing to Steve Jobs himself!!! (RIP.)
I already have an iPhone 11 and it works perfectly, no issues whatsoever, and (until I saw the iPhone 12 mini) I didn’t have a second thought about needing a new one!
I needed to talk myself down from the ledge, so I remembered to ask myself the important questions. “Do I want this?” (Hell yes, I do! It’s adorable!) “What will this really cost me?”
First, I took to the Compound Interest Calculator. I saw that if I put $800 into index funds and averaged a 7% rate of return instead of spending it on a new phone, I’d potentially have over $6,000 in 30 years when I’m ready to retire. Holy hidden cost, Batman!!
Then, I thought about how much time it would take me to earn that phone. I currently make about $25 per hour. That phone would cost me 32 hours of work! Almost a whole week’s pay for a new phone? That is crazy. I like to think this way when I’m tempted to purchase something new. Is it worth the time I worked to make that money? Then, I thought about how much time the hidden cost of the purchase would buy me back – aka, how much earlier could I quit working full time if I invested the opportunity cost now? For me, the hidden cost of $6k buys me almost 2 months of full-time earnings from my job. Would I rather buy a new phone when I don’t need it or retire 2 months earlier? Yeah, it really works like that!
To review, when you’re thinking about making a purchase, ask yourself these questions and consider:
Start working through these questions on even the small purchases in your life (like a $5 coffee). The more you can get familiar with compound interest, the faster you’ll be able to tell yourself “no” to things you don’t need.
Now that you’ve got the tools to talk yourself out of any purchase, you can start to FIRE THE “OLD YOU” and all your overspending habits and work diligently on the “NEW YOU” – the you who knows what opportunities your money will have if you let it!
Sure, like breaking any habit, FIRING overspending will take some time. You may not immediately see the point in turning down a $5 coffee today for $38.06 thirty years from now, and that’s okay. But I know for a fact that assessing your purchases this way consistently will change your spending habits over time and help you Live a Life You Love! I know it has for me.