Posted by Robert on August 22, 2011
This is a guest post by Robert, who lives in Calgary and
works as a financial adviserretired at 34. He is married, has three kids. Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.
Life sometimes feels like a long stream of choices. When we are faced with an income that’s not unlimited, our personal finances are defined by the choices we make. There are lots of things we can do with our money, but they can mostly be categorized into three groups: spending, debt service, and saving and investing. In order to have a certain outcome, such as retiring at age 45, we need to make tradeoffs between these three groups of choices.
Spending. The reason we work is to provide for our needs and the needs of those we care about. We use money as a medium of exchange to reduce trading costs. Money has no inherent value, except to enable consumption or to store value for future consumption. We spend on our needs and wants, but we also have other spending obligations and choices. We spend on taxes, because it’s mandatory and because the government provides services. Some people gamble and others buy insurance, for the possibility of either future gains or protecting future losses. Spending money produces our quality of life.
Debt service. This group should probably have come first in the list, because it is the least flexible. Before a person can make any other spending decisions, they need to make their debt payments to their lender, with interest. For every $1 borrowed, $1.05 (more or less) must be paid back. The interest is a leakage that represents money you never get to make choices about. It’s effectively money that you earn, but don’t get to spend or save. Sometimes debt is necessary, but the interest cost should always be minimized.
Saving and investing. For every $1 saved, $1.04 (more or less) is available for spending in the future. With a goal to retire early, saving becomes important because it allows future spending without working. But the goal is still to spend the money. Money that is saved but never spent is wasted. Most people that I’ve spoken with appear to have a goal to smooth spending over their lifetime, not being able to spend far more either now or in old age.
I’m the kind of person who would rather have my cake than eat it. My personal values are to keep spending low, in order to pay back debt quicker and also save and invest for the future. Some people would rather not plan to retire, but spend and enjoy their earnings now. I wouldn’t say that’s “wrong”, only a different set of priorities.
What tradeoffs do you make between spending, debt service and saving? What would you do differently?