Financial decisions vs. Investments: Saving cash is not equal to making money

Investments are entered into in an exclusive effort to generate cash, either on a one-time or residual basis. It really is as simple as that. However, a lot of folks out there use the term “investment” when describing their decision to purchase a really expensive couch, or a new coat for example.

Will that couch, and that coat, last for a really long time?

Maybe. In that case, spending the extra money now in order to keep from continually purchasing lower-quality items might be a great financial decision.

But those choices are precisely that: Financial decisions.

[Reading from The Simple Dollar: Why your home isn’t an investment]

Is your car an investment or a financial decision?

Understanding the difference between the terms “Investments” and “Financial Decision” can help bring to light several reasons why you may not have been able to stick to your budget last month — or why you’re still saddled with massive car payments.

I’m not at all saying to beat yourself over your purchasing decisions. Instead, I want to help all of us in our Ninja community understand our mindsets behind major purchases.

[Don’t miss: Understand the Sunk Cost Fallacy and how it affects your finances]

Can a car purchase be a great financial decision? Yes. If you have the money and choose a late-model used car, for example. In that case, your car will last a really long time, and in theory you will have paid substantially less than you would have for a new car while enjoying most of the benefits as your car was still built recently.

You can use the money you are not making on car payments to purchase index funds. That, friends, is part of the difference between an investment and a good financial decision.

If you purchase a car specifically to drive for Uber or Lyft in your free time, then you have bought a car in order to make money. That is an investment.

If you have chosen a solid, dependable car that fits your family’s needs and budget OVER a sleek sports car that guzzles premium gas and needs tons of repair work, then you have made a great financial decision.

What about something like a couch or a coat?

Let’s bring it back to some more everyday items instead of a major purchase like a car.

Earlier I mentioned couches and coats as examples of financial decisions compared to investments. Let’s explore this for a second.

If you spend $500 on a really great jacket as opposed to $100, you can expect your purchase to be of far higher quality. You can expect it to last far longer. Now, let’s say your friend bought the $100 jacket for a snowboarding trip you two were headed out on. His jacket is so flimsy that it rips as soon as you two hit the slopes.

Now he has to head to the shop and spend more money on another jacket, and this time maybe spends $200.

The following winter, he has to buy yet another jacket for $300 — making it $600 spent in total — and you are still sitting pretty with your one, $500 jacket.

Great financial decision, right?

Possibly.

What if, come the next season, your jacket is out of style? Will you be tempted to buy yet another expensive jacket to match the season? In that case, your financial decision-making was extremely poor.

Did you spend your savings on what could have been subsequent jacket purchases on things besides investments? In that case, again, you can’t consider the purchase an investment at all.

What happens next?

It’s up to you! That is both the fun and scary part of personal finance: Everything about it is just so darn personal.

Your choice, in the case of the dependable car against the sporty, will save you money over time. However, it’s what you do with that saved money after the fact that matters.

Let’s say for example that you had been making monthly, $300 payments for three years. After that time, your used car was paid off. That’s great! Your budget now has $300 freed up for whatever you like or need.

What to do? Do you inflate your lifestyle? Spending an extra $300 on restaurants every month moving forward?

If that will bring you literally the highest degree of life satisfaction, then yes, do exactly that.

However, there is an option that your future self will thank you dearly for: Invest, and reap the real rewards of making those good financial decisions. Yes, we’re talking about compound interest.

Your future self will get quite a bit of life satisfaction out of that.

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Check out the ongoing, full retirement ladder here:

Step 0: Create a budget that helps you get wealthy

Step 1: Why building an emergency fund is so important for your nest egg

Step 1.5: What type of account is best for your emergency fund?

Step 2: Contribute to your 401(k) up to the company match

Step 2.5: How should I pick the best 401(k) investments for me?

Step 3: Pay off all high-interest debt as aggressively as possible

2 Comments

  1. I think this is a good framework for understanding and classifying purchase and investment decisions. While I don’t think one ought to necessarily deprive oneself of a sports car if it’s what truly makes you happy, I do think that it’s foolhardy to look at it as an investment, like some people call it. It’s not; it’s an expense that will not generate any kind of monetary return in the future. And it’s certainly not prudent to call it an investment in order to justify a purchase decision that one can’t afford.

    September 7, 2017
    Reply
    • NestEggNinja said:

      We all see it all the time, especially surrounding major purchases that even the buyer might be inclined to admit wasn’t prudent. Yes, you’ll keep yourself from having to make another purchase in the near future, but you’re still out a major chunk of change with no real way of making that back outside of your job. If, instead, you used that money on money that would make MORE money, then you’d be investing smartly, and you could buy those expensive items later on with your passive income!

      September 7, 2017
      Reply

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