Monday, August 6, 2007

An Easy Way To Justify Your Frugality

J.D. wrote an excellent article about choices you have to do in life to reach your big goals. He discusses a few “tools” you can use in order to persuade yourself into not buying something in order to save money, and I believe there is one small addition I could do to his list.

In a nutshell he lists the following tools:
Keep you goal in mind: Focus on why you need to save money and keep reminding yourself of that. “Do I need an iPhone or a million dollars?”, “Do I need a Wii or to become debt-free?”.
Boost your income: Self explanatory. Put additional energy into making more income in order to save more.
Be patient: Progress increases over time because you will slowly and gradually pay (or receive) less (or more) interest as you continue focused.

One thing I do to keep my goal in mind is to calculate a comparison multiplier: I take the estimate time until I reach my goal (for example 10 years) and then I compound the interest I receive in my investments for 10 years. If I am getting 10% / year that means to multiply what I have by 1.10 after 1 year. After 10 years that means 1.10 ^ 10 = 2.59.

Now when I see a fancy new iPhone for $500 I ask myself: Do I need an iPhone or to be $1295 closer to my goal?

If your goal is to be debt-free it is even better. Interest on debt is generally a lot higher than interest you receive in investments. Let’s take J.D.’s credit card interest, which is 19.8%/year and calculate his multiplier for 10 years: 6.09! Does J.D. want an iPhone or to be $3045 closer to be debt free in 10 years time?

I know my personal answer. What is yours?


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