In my recent post summarizing my discretionary spending of 2013, I shared the numbers as a percentage of my gross income for that year. Mostly I did it so my spending would look less horrific, but I also did it because it’s a good way to look at your finances.
Things don’t cost what they are priced. How much something costs depends on your financial situation.
If you really want to put things in the context of whether or not you can “afford” them, consider whatever object your heart desires in context of your net worth or income. Regardless of the price tag of an item, it makes a big difference if spending money on it is an almost negligible dent to your bank account or a huge cut out of your life savings.
Think about it:
When I spend $200 on concert tickets as a salaried employee earning $75,000, this splurge represents only 0.27% of my income.
However, if I drop $200 on the same tickets as a starving student earning only $15,000, they now eat up 1.3% of my income.
So maybe in your head you’re thinking, “but that’s still a small amount, it doesn’t matter!” ok, but if I go to 10 concerts per year (and I probably will), then it’s only 2.7% of happily employed me’s income but a terrifying 13% of studious me’s income. And that’s about where I can’t afford it anymore. Most of us can fritter away 1 or 2 or even 5% of our gross income, but once we’re digging into double digits, it’s taking money away from our needs.
Another way to contextualize your spending is to think of it in terms of your net worth. If you’ve built up sizeable financial assets, a little splurge here or there isn’t going to rock the boat. However, if you don’t have anything substantial, or worse yet have a negative net worth, spending anything can make a big difference.
For example, if someone that has $50,000 in savings buys a $50 shirt, they’re only spending 0.1% of their net worth.
If someone else that’s only accumulated $500 buys a $50 shirt, they’re blowing 10% of their net worth. Scary, right?
The point of this is what you can really afford is relative. Blowing 10% of your net worth on a tshirt is stupid, you can’t afford that! But going to 10 concerts that cost less than 3% of your income is ok, even if they’re $200 apiece.
The more you earn and the more you save, the more you can safely spend without putting your financial security at risk.