Updated: Jun 23, 2018
The True Cost Factor
One of the biggest misconceptions about money that I often see is that income is the sole input to building wealth. Most individuals say, “If I made more money I would be set for life”. As easy as that is to say, that is not quite the reality. If you made 1 million dollars a year, but spend 1.1 million dollars a year, then you are broke. Actually, you are $100,000 in debt but you get the picture. Expenses play a huge role in the equation to building wealth! But it is the most common factor that is overlooked.
After years of studying personal finance and behavioral finance I think I have figured out what the problem is. As consumers we tend to undervalue or rather miscalculate the cost of a given purchase. We walk into a store, see something we like, check the price and say “$200 that’s not bad, I can make it back next week”. We do this over and over again in our day to day lives and don’t think much of it because it’s a relatively “small” purchase. Well what if I told you that $200 purchase really didn’t cost you $200…what if I told you it cost you thousands more than that? What do I mean you ask? Well that $200 is part of the cost, but you overlooked a substantially important cost as well. Let me introduce you to what I call the “True Cost Factor”.
The True Cost Factor is a fairly simple concept. The True Cost Factor shows you the “True Cost” that a purchase costs you because it takes into account what that money could have grown to if you had invested those funds. So let’s take a look at our example above: That $200 that you spent really didn’t cost you $200, it actually cost you about $4,855!!! How did I calculate this? I took the average rate of return of the S&P 500 (8%) and used a 40-year investing period (typical working life). The $4,855 shows you an accurate estimate of future income that you are missing out on by spending today. I know some of you are thinking, “$4,855 is not that much, definitely not worth putting off spending for some decades”, okay well lets up the ante a bit. Let’s say you spend $5,000 on a new TV and entertainment system. How much did that truly cost you? Drum roll please………A whopping $121,366.93! You just traded funding your son’s college tuition for Sunday Night football in your man cave. Let’s take it one step further, you buy a $50,000 new Chevy truck…..Survey says $1.2 Million!
Now the purpose of this blog is not to scare you away from spending any money today, but rather to inform you on the “True Cost” of your purchases. With this new mindset you will be empowered as a consumer to make educated decisions on purchases without being fooled by the price tag. This concept was tailored from David Bach “Latte Factor” which demonstrates how a daily $5 cup of coffee can cost you over $500,000 down the line. The overall point is that expenditures both large and small can have enormous financial impacts on our future, so keeping our cost low is imperative to achieving financial freedom!