As I wrote in a post before, my mentor in the personal finance space is Suze Orman. In her shows, she had a segment called, “Can I afford it” ? The idea was for people to call in with a purchase they had in mind. Suze would then evaluate their financial condition and then pronounce her judgment on whether the request was “approved” or “denied”. The requests for spending ranged from children’s private school fees to buying a boat and everything in between. This was a hugely popular segment and in true Indian TV industry style a couple of our shows tried to copy it. Obviously, it failed to take off as expected.
I think it will be a good idea to examine how she arrived at her pronouncements and see if we can apply some of her methods to determine the suitability of our spending. Suze had a fairly simple financial checklist for early denial of any spending which was not a mandatory expense. It went something like this:-
- Availability of an eight month emergency fund.
- No credit card outstanding for more than the current cycle.
- Contribute fully to the 401K plans ( equivalent to our PF )
- Spending not more than 4-6 months of take home pay ( except for house etc )
Anyone not fulfilling any of the above would be automatically denied, irrespective of whatever other asset base they had. The logic was simple – if you have been unable to inculcate some basic discipline in your financial life, you do not deserve to embark on any fresh spending. With shaky foundation, it is unwise to put more pressure of more floors in the building.
Once the basic criteria was fulfilled, Suze would go down to seeing whether the spending was linked to people or was just something for enhancing one’s self esteem. The other thing she looked at was the age of the person and how much amount there was in the investment account and retirement account. In her book, the retirement account was specifically for retirement whereas the investment account is for all other goals. Obviously, anyone over the age of 45 and not having enough in these accounts would often be denied for an expense which was really an indulgence, such as buying a boat.
Now, if we were to adopt her methods to decide whether we should or should not go for a spending which is out of the ordinary then it could go something like this:-
- Are you having an 8 month emergency fund ?
- Do you have adequate life and health insurance ?
- Do you always pay your credit card dues in full ?
- Do you have no loans or only a housing loan ?
- Will you be able to pay for the purchase directly ?
- Is the amount less than 4 months of your take home pay ?
- Do you have a financial plan and are investing for your goals ?
- Are all your goals funded adequately through your current investments ?
- Will you be able to stick to your investment plan, despite this spending ?
- Is this something that will bring happiness to you and your near and dear ones ?
If you are able to answer all of the above 10 questions with a “yes”, then I feel you have pretty much earned the right to go ahead and spend the money you need to. Sometimes, our money availability is good but we have neglected some of the things like an Emergency fund, due to sheer laziness. It will be good to fix such basic issues and then indulge in the spend.
Note that I have not included questions such as, “how much will this grow to if you invest in MF or stocks?” etc as that is not really the issue here. Investment and spending both have their own places and their own importance. As long as you fulfill the criteria, go ahead and spend for whatever purpose you wanted to – make sure that you enjoy it too.