By focusing on return on investment for every dollar you spend, you will get the most out of your purchases and avoid frivolous spending.
What makes a great investor great? When evaluating fund performance or financial advisors, what is the first and most important measure of their success? Return on investment* or getting the most out of every dollar regardless of whether it’s spent on a stock, bond, or physical asset. By maximizing return, great investors ensure that their money is working for them in the most efficient way possible.
While most people use this mindset to decide between buying or saving, this thought process usually ends once the wallets and pocket books start opening. If you are looking to get the most out of the money you earn, don’t stop your analysis once you’ve entered the store. This doesn’t mean you should be walking through the aisle of the grocery store trying to decide the return on Greek yogurt vs. Yoplait, but for larger purchases like cars, electronics, and even clothes, you should evaluate your options just as a fund manager would evaluate different securities:
- Evaluate ROIWhat is my return on this purchase? It can be difficult to attach a dollar figure to some returns, but get in the habit of asking yourself will I get enough out of this to justify the expense. Let’s say you’ve decided it’s time for a new watch (see what I did there?) and you find yourself looking at a $50 Timex and a $500 Citizen Eco Drive. Is the difference in what you will get out of the $500 really worth the additional $450?
- Consider Opportunity CostsWhen evaluating investments or projects, analyst often talk about opportunity costs that are the lost gain from using that money for another purpose. Since you’ve already made the decision to spend, it is worth asking yourself could this money be better used on a different purchase? Going back to the watch example, if spending $450 extra on the watch means you will not be able to spend more money on a nicer mattress, personal training sessions, or that trip to the beach then you need to weigh these lost opportunities before making a purchase.
- Put Your Money in the Highest Return ItemsIn other words, pay for quality on items you use the most like mattresses, cars, desk chairs, and computers. Not only will you get more use out of these items for longer but you might improve your day to day routine and health.
- Take the Time to Care for your InvestmentRoutine maintenance on cars, keeping the moths out of your closet, purchasing anti-virus software for your computer, by maximizing the longevity of your purchases you will be maximizing the return you realize on the money spent.
- Ask yourself if you can get the same return from a less expensive itemI love cars. I like to work on them on the weekends and am the kind of person that will actually travel an hour on a Sunday to find a scenic, exciting driving spot. So for me, it would be worth an extra $2000 to buy a sportier, more enjoyable to drive car over say a minivan. I can say confidently that the return I get would be worth the extra money. However, I may not have to make that choice. If I do my research, I might be able to find a car at the same price point as the minivan where the increased return on the more expense car is not high enough to justify the extra cash. Once you’ve decided to make a jump from one cost tier to another, it can still be worth it to look for savings within that same range.
Obviously, the biggest opportunity you’re giving up when making a purchase is the ability to save. However, treating expenses like investments will help you stretch your dollars to their maximum utility.
*For the purposes of this post, I won’t get into risk, but when evaluating returns across different portfolios, you must always take into account the risk adjusted rate of return. If one portfolio garners you an 8% return with downside risk of 10% to your portfolio, then adjusting for risk that is a better overall rate of return than a portfolio gaining 12% but with downside risk of 50% of the portfolio.