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How do you judge if you can afford something?
May 19, 2011 3:41 PM   Subscribe

How do you judge if you can afford something?

I've realised that, despite training as an economist, I don't have a mental framework for making financial choices. For instance, I'm thinking about buying a fun new road bike. In the narrowest sense of affordability (having enough money in the bank), I can easily pay for it. But beyond that, I have no idea where to begin in setting myself a maximum amount to spend.

Obviously this is partly a subjective judgement. But without some kind of coherent way of thinking about this sort of decision, it seems unlikely that my choices are maximising my utility. It must be possible to do better!

So, Metafilter: Do you have some kind of mental framework for judging what is affordable? Do you set some firm long-term financial goals and then work out how much spending you can afford? Or seek to achieve a certain material standard of living now and save whatever's left?

Or do you use some kind of rule of thumb? Do you just rely on a vague sense of what 'feels' affordable?

And if you do have a system, does it work?

For context, I'm: early 20s, in the UK, with some savings, in a comfortable but not particularly high-paying job.
posted by matthewr to Work & Money (23 answers total) 28 users marked this as a favorite
 
Since I recognize that I am human, I define affordability in terms of aversion to potential future losses. If losing a thing that I want would ruin my day/year/life, then I can't afford it.
posted by FreedomTickler at 3:54 PM on May 19, 2011


The word budget is in your tags, but you don't mention it in your post. What gives? The difference between people who are good with money and those who aren't isn't that they know some rule of thumb. It's that they track their expenses carefully.

Sign up with Mint (or whatever), and divide your income into monthly expenses, long term savings, and new toys. When you've saved enough in your new toys budget, buy yourself that bike.
posted by auto-correct at 3:55 PM on May 19, 2011 [4 favorites]


I give myself a discretionary spending limit of (max) 10% of my net income each month. If I go over one month, I cut back for the next few, but I don't roll over the excess if I don't hit the maximum. I first learned this method the year I asked for a violin and got nothing other little presents besides that for that Christmas and my next birthday.

I also try to plan ahead for large expenditures, dividing the "payments" over the course of a long period and stick it all in a separate account - that is to say, the Christmas Club method. In those cases, I focus on judging whether the expenditure is appropriate in other ways (this is where the "feels affordable" thing tends to come in.) I give myself permission not to count that purchase and the installments against my monthly maximum, in exchange for this demonstration of self discipline.

I find the second method more reliable than the first, mostly because the costs are hidden and the benefits flashy.

Also: I don't use credit cards. I suspect my first method would fail in the face of a credit limit equal to even half of a month's income.
posted by SMPA at 3:57 PM on May 19, 2011


If you have dependents who will suffer from hunger or other financial issue from the redirected funds then you can not afford it. I guess we are also dependent on ourselves, but if you're willing to go hungry for a bike, that's ok, not so much your kids or parents.
posted by sammyo at 4:01 PM on May 19, 2011


I work out how many hours of work I would have to do to pay for the thing I want, and then compare that to how much use/pleasure I would get out of the thing I want. It's easier to decide if it's worth it to me if I have to count how many hours of work drudgery it would cost.
posted by malibustacey9999 at 4:01 PM on May 19, 2011 [11 favorites]


Early 30s, in the US: My general rule of thumb is that I limit my credit card to ~$500 a month and pay it off every month. So when I want something pricier, I have to skimp the rest of the month to make sure I don't go overbudget too much. Or if I have an uber-high bill one month, the next month it's just gas & groceries. It's easy and I have a healthy savings account to show for it.
posted by jabes at 4:02 PM on May 19, 2011


If you're looking to get the most utility, consider this book -- the idea behind it is analyzing what you spend according to how much value you feel you derive from it.
posted by emumimic at 4:02 PM on May 19, 2011


I too am an economist. Econ theory would tell us to maximizes based on our budget constraint. Solving that for an infinite number of goods is complex. How I budget (common technique in personal finance) is that I save first. Before my pay check is transfered to my checking from savings account, I deduct savings for retirement, house fund, future travel plans, daughter's college fund, and giving the charity. If I want to buy something big I have a separate account for that.

In short just have a budget for discretionary spending so if it is within that budget then good.


Now how much to save for all those other things that is another question.
posted by akabobo at 4:15 PM on May 19, 2011 [2 favorites]


Mid 20's Canadian professional in Vancouver (relatively expensive, for North America), YMMV:

I have a base percentage for each month that gives me a lot of leeway:
20% - Housing
~5% - Utilities (Phone, internet, hydro, cable)
25% - Long Term Savings (RRSP, RSP, etc.)
20% - Short Term Savings (Travel, large purchases, potential downpayments, etc.)
10% - Food & Drink (incl. alcohol)
20% - Discretionary

Since I'm relatively young, have no major financial commitments (no mortgage, no car, no student debt), and do not carry a balance on my credit cards, that 'Discretionary' column really goes everywhere: concerts, skiing, transit, activities... Savings are all timed direct deposits, so there's no cheating. I don't lay out over $1000 at a time from my discretionary budget, that has to come from my short-term savings. Anything unspent from the last 2 lines goes 70/30 split into savings.

A basic value proposition of cost/(usage*lifetime) is a good idea for affordability, but think more qualitatively than quantitatively. ie: this bike is my main mode of transportation, and will last a long-ass time if I keep it in good shape, so I'm willing to spend more. Or: there are a few games I'd like an Xbox for, but between my computer and PS3 I can't justify getting one. Or: yes, I will go on that long-weekend trip with my friends because some serious Hangover-type shit is going to go down and I need to see it.
posted by t_dubs at 4:16 PM on May 19, 2011 [7 favorites]


I don't carry credit card debt, so if I can't afford to pay it off in full that month, I won't buy it. I also consider the long term cost of the thing. If I'm going to need to feed money into it regularly (ongoing fees or maintenance), can I comfortably pay for that without sacrificing in other areas of my life including adding to my savings? Then I consider pure gut - how much do I want it. Am I going to look at it month after month and wish I had the money back instead?
posted by cecic at 4:16 PM on May 19, 2011


You have to manage the money against the imponderable, which in this case is that if you have a good quality bike, you might well exercise more and that would provide benefits that can't be quantified. Also a good bike is "cheaper" in the long term than a crappy bike made of cheap material that bends and breaks and has to be patched up. A good bike is often a reasonable investment in terms of exercise and transportation ...if you use it.

I think even if you're doing OK financially, occasionally you have to size up your situation and see whether you're indulging yourself too often – are you surrounded by expensive items you never use? Are you rewarding yourself with too many instances of unnecessary spending? I don't think there's a hard and fast rule for this. Only you can know where your balance of comfort is.
posted by zadcat at 4:16 PM on May 19, 2011


Afford it is not just the cash in the pocket, plastic in the wallet.

When presented with 2 or more options buying the most expensive might be the better decision if use, quality and longevity are important. So paying more now is more affordable than paying less now but buying a replacement sooner.

For a bike? I'd find cycling forums, read Amazon reviews and from there see at what point the money being spent is going to be wasted in performance areas I'd never hit. Then I'd wait a week or two and then I'd get the cash - it's surprising just how hard it can be to pay for something in real folding money.

But affordable isn't just the big stuff - how much do you spend on drinks, driving, food etc? Is that affordable? The 'look after the pennies and the pounds look after themselves' is true.
posted by episodic at 4:20 PM on May 19, 2011


Price a few different models of this bike (is it a bicycle or a motorcycle?). You can do this easily by looking at prices on eBay or in a consumer magazine. The prices of different models are distributed over a range. Now:

Where do your preferred models fall on that distribution? Maybe this should be quantified in terms of standard deviations. Call it S.
Where does your income fall on a distribution for your profession/age/location? Likewise. Call it I.

Calculate S/I. Is this 'fun' something casual or a deeply felt passion? If the former, then you probably want to set a price ceiling that reflects your overall financial situation. If the latter, then treat the proportion > 1 as your opportunity cost and ask yourself what you'd be willing to sacrifice in the future. If it's going to be really expensive, but your really want it, then ask yourself what you already have that you would be willing to sell.
posted by anigbrowl at 4:29 PM on May 19, 2011


Not that I've stuck to this my whole life (I haven't), but I think optimally I can afford something when all of the following requirements are met:

1. I have no *bad* debt (I classify student loans and mortgage as good debt and possibly a car loan if it has a low interest rate)
2. I have six months of living expenses saved in an emergency fund;
3. I am meeting my retirement goals (10 to 15 % of all income being saved for retirement)
4. I can pay for the item without imperiling 1-3 and have enough left over to get to the next paycheck.
posted by bananafish at 4:46 PM on May 19, 2011 [1 favorite]


I don't have a thorough system, but rather some basic strategies. I pay off my credit card ASAP. In order to buy 'nice things' I keep my ongoing outgoings as low as possible. I regularly go through my bills and try to get rid of anything unnecessary or look at getting better deals for things as needed (say, every couple of months). I try to save as much as possible in order to a) buy nice things and b) have a cushion there if I need it.

I will pay more for things if I know they will last longer/I will want to keep them for longer. And if necessary I will cut back in some areas in order to 'afford' it if the benefits of having x outway having y.

I will also spend a long time thinking about buying x - mull over it, do research, forget about it. If I still want it after a long period of time or it becomes that I need it for some reason, then I'll buy it. Otherwise these things often become expensive ornaments.
posted by mleigh at 4:53 PM on May 19, 2011


Assuming we all share the dream of living entirely off our principle, you must ask yourself how quickly do you want to reach that goal and how much are you willing to sacrifice to get there.

The bike raise some specific questions. Do you have a bike already? If so, is it servicable? Is the one you have in mind for work or exercise? How much use, honestly, do you think you would you get out of it? If it proves disappointing, how much can you get for it on the aftermarket?

Money is theoretically a growing asset whereas most any consumable is depreciating. Guilty until proven innocent.
posted by IndigoJones at 5:03 PM on May 19, 2011


So I separate this problem into two: "macro" (how do I calibrate my expenditures over a longer period?) and "micro" (do I buy this particular thing).

First, micro. Usually I try to compare a purchase to other purchases I might make and see if it sounds reasonable or unreasonable. For instance: In general this helps me keep the utility bar for my various expenditures relatively even across categories. But how to choose the bar? Every month or so I look over my past few months' expenditures, divided into categories (groceries, restaurants, stuff I bought, going out to things) and see whether it's an amount I'm comfortable spending based on my income and long-term plans. That way I can decide to raise the bar, if I think I'm spending too little (and next time I have borderline expenditures I can tell myself, "go ahead! You've earned it!") or too much (and do the opposite). Seems to work for me in general.
posted by goingonit at 5:06 PM on May 19, 2011 [4 favorites]


One approach is to set your savings targets, and once you're meeting them, you can spend what's left guilt-free. Elizabeth Warren and her daughter wrote a book a few years ago called All Your Worth, that suggests most people will do well if they keep needs and committed expenses to 50% of net income, and set savings to 20%, leaving 30% for wants. I've since seen a couple of other books that build on the Warrens' model.

Beyond that, as zadcat said up-thread, how much satisfaction you get from specific purchases is pretty subjective. I think you figure out over time by trial and error what kinds of purchases leave you satisfied and unsatisfied, and I have found that that changes over time.
posted by not that girl at 9:23 PM on May 19, 2011 [2 favorites]


I think taking a satisficing approach to each purchase leads to overall maximum utility, since it often leaves you with leftover money to spend on other things, and a variety of things are better because of diminishing marginal utility from consuming each particular type of good or service.

So figure out your "must have" criteria for your purchase and then evaluate the possibilities by starting with the least expensive option and working your way up in order of expensiveness. As soon as you find the option that meets your needs, STOP.

No need to compare all the options (search costs!!!) or drive yourself nuts about whether you want to spend an extra $200 on some feature you don't really need because you're not sure whether the marginal benefit is worth the marginal cost.
posted by Jacqueline at 10:33 PM on May 19, 2011


Maximizing utility isn't a sensible objective, or something to strive for - it's at best a descriptive tautology. Utility is an arbitrary index assigned to possible consumption bundles in a way that is consistent with your observable behavior - that is, it is assigned such that it at is maximum, within a budget set, at your chosen bundle. Anyone who tells you anything different is selling you snake oil.

Survey all your options for how to spend all of your money (including future earnings, and include among the options: saving , leisure, insurance, and spending more money, time, or resources on further surveying your options). Now choose one of those options. If you want to ensure that the option you choose is the one that will make you the "happiest" or most "satisfied" or something, then your best strategy is to learn a bit about yourself. What makes you happy? What really satisfies you? And how is that likely to change over time? Use that self-knowledge (typically gained through self-observation, and trial and error) to guide your selection.

If you're still worried about maximizing utility, arbitrarily assign some number of "utils" to the option you chose. Now assign a smaller number to every other affordable option you didn't choose. Your utility is now maximized.

If you're worried that you would have liked a different option more, then ask yourself two questions: (1) why didn't you choose it, and (2) did you have that information available to you when you made your choice? If the answer to (2) is "yes," commence face-palming and squirming with regret (and possibly self-loathing).

In all seriousness - people are in general really bad about respecting their future selves. Try to plan over your whole life-cycle. Chances are good that, down the road, you'll be glad you bought a cheaper bike and saved the difference. If you're on the fence, think about saving. Take a broad view of how a particular purchase will fit into your life going forward (over a possibly long horizon). And don't forget about insurance - particularly disability insurance.

It's a fun exercise to create a spreadsheet that estimates your life earnings, and savings necessary in each period to smooth your consumption over time. You'll need some basic actuarial data, estimates for income growth, interest rates, etc. Try it! You'll quickly see the importance of compounding interest on early savings, and maybe think more carefully about how much that bike really costs you.
posted by dilettanti at 11:56 PM on May 19, 2011


Few people actually know what they spend their money on. A colleague recently told me he'd had a ridiculously high tax demand (which he knew was coming because he knew he was being assessed on historic much lower income levels). So to pay that tax bill he needed to revisit his cash flow. And to help him do that he did a look back analysis to see what he'd spent his income on in the last 12 months. And he came up with a "black hole" of about EUR20k......he had spent a vast amount of money with absolutely nothing to show for it...I didn't say anything but even I could have told him that nights out feature heavily in that category....and clearly there's nothing wrong with having fun but he and his family now have to cut down a bit to pay the tax bill so perhaps not the wisest way to use his income.

Not suggesting you're as carefree in your spending as my colleague. But most of us don't know exactly where our money goes. So my suggestion is to track every £ you spend for a month or two - and I mean every £. You'll be astonished what you spend money on. A good chunk won't be essentials.

Armed with that knowledge you can look at what your net income is and what your regular outgoings are and come up with a budget. The budget wants to include stuff like savings (long-term), short term savings to smooth your cash flow i.e. any known annual or six monthly payments, any expected but not definite things like car repairs etc. It needs to include your normal monthly outgoings. And what's left you can spend on such things as food, going out, a nice fancy bike. How much goes into the long-term savings will depend on what you do about pension, are you trying to get a deposit together for a house etc.

But my starting point would always be to work out what you spend your money on - if you want to free up additional cash for anything that's where you will find it and if you want tomake a conscious decision about what you spend your income on that's what will help you.
posted by koahiatamadl at 1:33 AM on May 20, 2011


monthly income - monthly expenses (bills, rent, food) - money I want to put in savings (a minimum of 10%) = money that I can spend on whatever.

It usually goes on diet coke and haberdashery.
posted by teraspawn at 5:56 AM on May 20, 2011


Affordability obviously means different things for a need and for a want. A luxury item may be less desirable to work into a tight budget than something you need. A road bike could fit into either category depending on your use. Will you use it to commute to work, thus saving gas money, parking costs, or fares? Will you use it as a means of exercise, saving you gym costs? If you use it solely for fun, then it is more of a luxury which would be ok if you didn't have to scrimp on necessities or more useful luxuries.
posted by JJ86 at 6:13 AM on May 20, 2011


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