Take automobiles. I’m in California – a place where many have bought into the myth that you are what you drive. A car is a necessity; but, it can be a luxury, too. And, the real cost of luxury can be more than expected.
Let’s use a simple example (I’m good at simple): You have the choice between a $25,000 car and a more luxurious $50,000 car. Let’s assume you have sufficient income and good size savings, so you can afford either one. In fact, you don’t even have to finance your purchase – you can pay cash!
One variable, of course, is your age: how long until you have to retire. Why is that important? Let’s see.
Let’s assume you have 20 years left before retirement and you can afford the $50,000 car. You buy it. How much did you spend? Now we get into time-value of money and how much that money could have earned elsewhere. Since you opted for the $50,000 car instead of the $25,000 car, the difference in spend is $25,000 (you do need a car, so it’s the difference between necessity and luxury).
If that additional $25,000 had been invested at earned a long-term average annual return of 6% in a balanced portfolio, it would have grown to $80,178 (for simplicities sake, I’m ignoring taxes and expenses in this example).
Suppose you bought a new luxury car every five years. The next $25,000 expenditure invested the same way would have grown for 15 years to just under $60,000. The third car growing for ten years would have grown to over $44,000. You get the idea: these three cars cost about $184,000 extra of retirement money because of the desire for luxury.
$184,000 over 20 years may not seem like the end of the world; and, at 2.5% inflation, it is worth just over $112,000 in today’s purchasing power. But, when you realize that the car may not be the only luxury purchase you make over a twenty year period, all those dimes and pennies can add up.
I’m sure I’m not the only financial advisor whose most successful clients are driving older cars, not throwing money at depreciating assets. A good lesson for our kids and grandchildren, too.
Are you planning your future? You can begin your journey here.
Jim
