For my 9-5 job, I work as a financial analyst for a Fortune 50 company. This company spends billions of dollars each year in order to manufacture high-end technology. My job is to forecast depreciation for the entire company. I’m going to get a little “financy” here for a minute, so hang with me– I promise I’ll make it relevant to you!
From a high-level, here’s how things work at my company:
- The sales and marketing team forecasts how much product they think the company will sell in the future
- The company figures out how much equipment is needed to manufacture that amount of product
- The company then purchases the equipment needed to produce the forecasted product needs
For the past several years the sales and marketing team have been extremely liberal with their forecast. And why not? The more product we’re EXPECTED to sell, the better the company looks.
Enter the issue
The issue is, for a myriad of reasons, the company is unable to use all of these buildings and equipment purchased. This is a problem because the company has spent billions of dollars on equipment which isn’t being fully utilized.
So why is having extra equipment laying around a big deal? The problem is, when those expensive machines start depreciating, they depreciate (this shows up as an expense on your books) regardless of whether you’re fully using them or not. If you’re not selling enough product to offset the depreciating equipment, this destroys your margins and robs your company of profit.
When your profit margins aren’t good, this impacts the company’s stock price and now we have a lot of unhappy shareholders.
The company has purchased the equipment, now they’re forced to face the consequences.
So why do I share that information with you? When you spend a bunch of money on superfluous things it’s as if you’re purchasing a bunch of unnecessary equipment. Perhaps well-intentioned at first, soon this extra “stuff” ends up weighing you down and hinders your financial goals and bottom line.
A good analogy I like to think of is: spending habits are like concrete, once established, they’re difficult to change.
I am not one to tell you what you should or shouldn’t buy– it’s your hard-earned money. But what I do know is, once you increase your standard of living, it’s difficult to go back. Those spending habits you establish will likely remain unchanged unless circumstances force you to change.
An example of this was when about a year ago we upgraded to a 2,100 square foot house from our small 2 bedroom apartment. That alone dramatically increased our spending. Where we were spending just under $1,000 a month for our 2 bedroom apartment before; now after our mortgage, $700 in extra payments to accelerate payoff, HOA, and utilities we’re up to $2,300 total. I understand that we are building equity, but regardless, our monthly cash flow has now decreased by $1,300 a month.
The hardest part about this is- I love our house! I love the room we have, I love our pool, I love not having the neighbor kids literally playing on our porch every day, I love not having to dodge surprises left by the neighbors’ dogs on my walk out to my car, and I don’t miss all the bugs in our apartment.
Despite me being happier now… I was also happy in that apartment too. I didn’t NEED to upgrade to a house, but now that I have, it would be incredibly hard for me to go back to apartment living because I’ve accustomed myself to a higher standard of living.
Think before you mix the concrete
The point of this article isn’t to tell you not to spend or enjoy your money; rather, I challenge you to become more cognizant of your purchases and their impact. Avoid establishing a foundation of reckless spending habits, because once you start down that path, it’s difficult to back-peddle, the concrete has more-of-less been laid.
Thinking back to what is financial independence, the larger the gap between your income and your expenses, the faster you’ll become financially independent. As you earn more money, and if you can maintain that gap and avoid lifestyle inflation, your path to Financial Independence will be much shorter.
Do today what others won’t, so that you can live tomorrow the way others can’t
This saying has become my motto over the past few years. Aside from the house, my wife and I try to spend as little as we can now, knowing life is only going to become more expensive as we add kids and other future expenses to the equation. We’re consciously holding off on laying a bunch of unnecessary “concrete” and instead focusing on spending money on things that bring us value, like experiences.
As much as this might be an unpopular thing to say, I think that it’s okay to experience a little discomfort today so you can reap the rewards later. Because of the sacrifices, we’ve made, my wife and I now have a portfolio that already works incredibly hard for us.
Right now I am 29 and we have a portfolio of approximately $400k. According to the Rule of 72, assuming an average rate of return of 8%, my money should double every 9 years– that means it should double 4 times by the time I reach the traditional retirement age of 65:
- Current, age 29- $400k
- First double, age 38- $800k
- Second double, age 47- $1.6M
- Third double, age 56- $3.2M
- Fourth double, age 65- $6.4M
Because we have “sacrificed” a little bit over the past 5 years we could never save another dime for the rest of our lives and have a portfolio of over 6 million dollars in 35 years. That’s the power of compound interest and putting your money to work for you, rather than dumping it into depreciating assets!
Think about what “concrete” you may have in your life right now, or are planning to add. What little sacrifices you can make today so you aren’t forced to sacrifice in the future?