Friday, June 29, 2007

Paying less for what you usually buy

This post falls into the category "How to spend your money correctly", as said here.

Money is like mass, energy and many other conservative entities, which means that you can write a money conservation equation:

(money you save) = (money you earn) - (money you spend)

This equation tells us, basically two things:
1) money does not disappear.
2) to save more money you can either earn more money, or spend less money. Each $1 you earn more, or that you spend less, has the exact same impact on your savings.

That said, lets work on spending less money. The easiest way to spend less money is not to spend money, a.k.a do not go out, do not buy things, do not pay for anything, but that is not possible. There are ways with which you can spend less money buying the same things.

First, research prices before buying. Look for 2-3 suppliers of what you are buying and check the best price. It does not matter if it is a mobile phone service, a car or a can of soda, each $1 counts. An example of a very good price finder is Google Product Search. Or Price Watch for computer-related products.

When buying, choose the best payment option. This one is more complex. The best payment option is the one that has the lowest net present value.

The net present value is a number that means how much all the money you will pay is worth now. $1 today is not worth $1 in month from now, because if you had $1 today you could invest it and make it be worth $1.01 or even more. So lets look at this through an example:

Payment option 1: You can pay in cash $100 today.
Payment option 2: You can pay by credit card $100 and your credit card bill needs to be paid in 30 days.

At first a look both seem the same. But if you look closer option 1 is more expensive than option 2, because in option 2 you could just take your $100 cash and invest for a month, pay your credit card bill and then have a residual profit. In other words, option 2 has smaller net present value.

Does it really make such a difference? If what you are buying is valued at $100, we may be talking about $1 or less. Try repeating that calculation when you are buying a house or something with considerable value.

For more complex payment structures, where you have an upfront payment and then monthly payments you will need a financial calculator (HP 12C), MS Excel or similar. Wikipedia has a great article explaining, in depth, how to calculate it.

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