Today I want to suggest a New Year’s resolution that is guaranteed to improve your bottom line. It’s a simple concept really… Do not purchase a good or service until you have saved the money to pay for it. Period.
So why is this so hard for us to grasp, adopt, and live by? It’s not complicated, it’s not unreasonable, and it makes perfect sense. So what’s the deal? Why do most Americans spend money that they don’t have?
Well, I don’t have the answer for that, so… Rather than opening that can of worms, I will present sound information that will help us grasp the Save Then Buy concept, adopt this commonsense philosophy, and live by the wisdom of it’s simplicity.
Save money, then buy – grasp the concept
If people would simply take a step back and rationally analyze the Save Then Buy mindset, there’s little chance that they could come up with a valid argument against it. Moreover, if one were to make an equitable comparison between the Save Then Buy mindset and the modern American cultural norm of Buy Now Pay Later, there’s little doubt that they would deem the former as the best financial choice.
If we can see the wisdom of the concept, but have not yet adopted it… What is holding us back?
An example
Let’s take a look at a simple example of Save Then Buy versus Buy Now Pay Later in the context of a college education…
Save Then Buy: A prospective college student might seek a low level job in an industry of interest, then either attend classes while earning enough to fund them, or save for a few years and begin schooling once they have enough saved, gathering no debt along the way.
Buy Now Pay Later: With this mindset, a prospective student would first seek financial aid (most often in the form of loans), amass a mountain of debt throughout their college years, and graduate with tens of thousands of dollars of student loan debt.
While some might argue about the value of getting that college education as quickly as possible, my view is that the Save Then Buy student will come out on top across the board. They will have gained work experience prior to and during their education which will help them refine their field of study, and will provide them with necessary experience for launching their new career.
In fact, they will often already have a job with a company in their field of expertise, and can start climbing up the ladder with their new degree. They’ll also start their professional life with no student loan debt, and can begin saving and investing out of the gate.
The Buy Now Pay Later student will graduate with no relevant job experience, no job, and a mountain of debt. They will have to go into the world and compete against better equipped Save Then Buy candidates.
Save money, then buy – adopt the philosophy
I’m guessing that many people reading this article currently have a Buy Now Pay Later mindset. That’s okay… I used to be hold that view myself.
The good news is that you can change your behavior today. You no longer have to be a slave to a poor economic mindset just because “everybody else is doing it.” Break free from a culture of temptation and start living by a new personal economic mindset that is based on wisdom and sound financial principles.
Will it be hard?
Sure… It might be. Was it hard for me? Not really. All I had to do was calculate how much our debt was costing us. Once I had the numbers in front of me, the reality of $1, 300+ of my hard earned money going toward interest on my debt was all the motivation I needed.
Get mad at your debt
You should sit down and take a long hard look at how much your debt costs. I can virtually guarantee that you will wind up with some good healthy anger toward your debt, which should help motivate you to adopt the Save Then Buy philosophy.
Save money, then buy – live by simple wisdom
Now that we’ve fully explored the concept, analyzed the numbers, and gotten mad about our current situation, all that remains to be done is to adopt the concept. Don’t buy stuff you can’t afford. Instead, save your money money until you can comfortably afford the expenditure.
From laborer to capitalist
In making this transition, you should also stop thinking like someone who trades their time for money, and instead start thinking like someone whose goal is to live off the proceeds of their money. If we want to win with money, we have to start considering our future every time we open our wallets. With each decision we make, we should be moving ourselves closer to the wise goal of living off the proceeds of our assets.
Second what everyone else says. Good overall point, but the save for college first example doesn’t add up. I’m honestly trying to do that now with grad school and eventually it’s just not going to make sense. As my graduate study will cost upwards of $150k, I’m just not going to be able to afford that for another 10 years. And by that time I’ll probably have kids and won’t have the time to go to grad school. So there are SOME THINGS like EDUCATION that make sense to pay for in loans. But lots of things… especially anything you don’t NEED… shouldn’t be paid for with money you don’t have. Plenty of examples of this, it’s a shame you used education to support your point.
I’ve transformed my mentality in the last year from the buy now, pay later to the save first, then acquire philosophy. A year a go today I was in Indonesia on the vacation of a lifetime. I had a friend who was living there and it seemed like a really great opportunity to go. I don’t regret it, but about 60% of the cost went straight onto a credit card. If I had skipped that trip I would probably be 3-6 months ahead of where I am on my finances.
I bought my house in October. Part of my down payment was generated by charging living expenses to a 0% interest credit card over the summer.
Between those 2 decisions, I now have a pretty good-sized pile of unsecured debt which I plan to have eliminated this year. Since I bought my house all of my living expenses have been paid for up front and my balances are slowly shrinking. This time next year I want to have 0 consumer debt, 24% equity in my house, and still have 2 vehicles paid in full. In order to do that I will have to stay disciplined and not create any more debts than what I already have.
@Wojo: Your comment totally nails the spirit with which I wrote this post. I understand what everyone is saying about the poor example and about not using numbers – my bad, I’ll do better next time – but what you say about debt presuming upon future income is EXACTLY why saving then buying is usually the wise route.
Irrespective of the one-sided debate going on about college financing, I do think your point stands. Everyone will make their own choice, of course, on whether making an extra payment is worth having something 12 months earlier, but I think a larger point is missed in such a debate:
The danger of buying something into the future is assuming that your income will continue (at the very least, at similar levels) in order to pay off that purchase. That’s a VERY gutsy assumption for many, especially these days. The opposite approach is to work with income that’s already been earned and saved.
Thoughts?
I have to say that for most folks who, like myself, don’t know at 18 what they want to do professionally, what their chances are in that career, or what the job market will be like in 4 years – I do think getting a job and saving up for college is the way to go.
And the list of expenses the first commenter gave – I managed to get through a full five years of college without owning a car, got a (used) car for graduation, drove it til it was totalled (3 years) and then didn’t own another for five more years. THe real answer to “if you are going to take 5 years to save $5k, finacne the car” is spend $500 on a nice bike & gear, instead.
“Why do most Americans spend money that they don’t have?”
==> Instant gratification! Americans have become the equivalent of a bunch of whiny little 5 year olds, constantly whining “But I want it nooooowwwwww!”
Poor example with the college. Although I did pretty much what you said and graduated in 5 years with no student loans (and by the time I was finishing off my masters degree, also working full time while earning the degree part time, I was already making 20-25% more than the other masters graduates were being offered for their first jobs), most people don’t have the stamina or brains to do that – I won’t lie, it wasn’t easy! I lived on 4 hours of sleep/night for years while I did it! You should have selected furniture or big screen TVs – durable goods, like Frugal Miser said – those are things I am seeing a lot of people finance lately. And b/c they can finance, they usually go for the “bigger & better” items – the items they truly can’t afford. If they only knew how much their decisions REALLY cost them….
It really is irritating to see people destroying themselves financially, isn’t it?
Good points Abigail, there are always exceptions but the rule stands.
Your second points about rates reinforces the truth that when saving before buying you never have to worry about crummy tactics used by creditors.
I think another interesting aspect that might have been explored is the lure of 0 percent interest. In some cases, it’s great. To use a previous example, Best Buy often offers you 0% for the first 12 months on amounts over $500. When my old computer died and I needed a new one to work from home, it was about my only choice. (I was living on help from my mom, who couldn’t loan me the $550 I needed.) That gave me time to wait for the various rebates to come back in. I made the minimum payments until the rebates came in and my job started providing slightly regular checks. They were relatively puny, so I could only pay twice the minimum. But I ended up paying it off only 1 or 2 months after interest attached. Given my very, very bad financial situation it was the best solution available.
That said, some financing options have a loophole: If you don’t pay off the total amount by the end of the 0 percent period, you owe retroactive interest. Youch.
Another point: Stores offer you credit because you’ll use it after the original purchase. You only get it for one item at Target — because you save money! — but then since you have a balance you’re paying off anyway, over time you add a couple of items and… voila. You have a balance that never quite goes away.
@DL: Your advice is solid, I will take it and use it in hopes of becoming a stronger personal finance writer, and I thank you for it.
Nickel: I think you’re conflating two separate points.
Yes, getting a cheaper car is a fine way to reduce your expenses. But once you’ve decided on the cheaper car, if it’s going to take you *any time at all* to save up the money to buy it, you’re better off financing it, because the interest costs less than the time you save on your commute. For a shorter loan term, it makes *more* sense: at 36 months, each hour of commute you save costs only $1.33. At 12 months, it’s only $1.26.
(Not to mention that in real life, owning a car doesn’t just save you time – it opens up new possibilities, including job opportunities.)
Matt,
If you pick a poor example to illustrate your point (and in this case, pick an example that DISPROVES your point), then why should we assume that your overall point is still valid?
Truth be told, I think you will serve yourself and your readers (and Nickel’s readers too) better if you use some real numbers to back up your examples. There’s only so many times you can write “financing things is bad” while keeping the content fresh and the readers interested.
For instance, let’s talk about Nickel’s example, financing an HDTV from Best Buy. Your premise says that “financing things is bad. Save your money.” You can make for a richer, more thought provoking post as follows:
For the sake of argument, let’s assume that the interest rate at BB is 20%, you don’t have the money up front, and you can only save $100/mo. There’s a TV you like for $1000. You can finance it, or you can save for it. If you finance it, and expect to make 12 equal payments beginning next month, your payments will be $92.63. You paid $111.56, or $9.29/mo in interest. The flip side is, if you opt to save your money, it would take you 11 months saving $92.63. The difference in financing is a little bit more than one monthly payment! That’s not much when you consider you get to enjoy the TV for an additional 11 months. (Put differently, it cost you $9.29/mo to enjoy the TV for 11 additional months.)
Reasons not to finance? Well, if you adhere to a “strict” emergency fund that requires you to have X months worth of bills in the bank, you’d have to beef up your emergency fund to accommodate the extra payment. From a cash flow standpoint, that could be difficult for some people, and for me, is a compelling enough reason to NOT finance, no matter how great the deal. (In accounting, the TV would be a liability until it is paid in full.)
So, buy providing real numbers to back up your examples, you can show us why a given choice is poor or good. In the example above, the readers can decide whether or not it’s worth $9.29/mo to enjoy a TV for an extra 11 months. I believe that this advice holds true for any personal finance topic one chooses to write about — picking real numbers forces you to critically think about the overall point you are trying to make, and in turn, makes for more thought provoking content. And you will be a better blogger for it.
Jesse: If it’s going to take you five years to save up enough money to buy a $5k car, then you might consider financing it instead. Either that, or buy a cheaper car sooner. The point here is that if the choice is between paying cash for a used car or financing a new one, I would buy the used car. It keeps you off the bus, thereby saving you all those hours, and you won’t be paying interest on a rapidly depreciating asset. I’m pretty sure that you can still see the larger point here.
Nickel: “For example, save up the cash and buy a used car instead of financing a new one.”
Why not finance the used car? Recalculating the example in my previous comment for a $5000 car, I see that for 60 month financing at 6%, you come out ahead if your time is worth more than $1.42 per hour.
Ha ha! Well I am happy to see that FCN commentators have some fire in their bellies. You all make some excellent points and let me just say that I did use a poor example… but rather than debating the proper path of college funding, let’s focus on the point of the article despite my poor example.
Of course there are always exceptions to every rule, but the majority of the time it is wise for us to save money for purchases rather than make purchases and pay for them later.
I tend to agree with much of the above. While, as a general rule, it is smart not to borrow to buy, there are definitely exceptions. I’d be willing to bet that if Matt chose a different example, everyone would be on board.
For example, save up the cash and buy a used car instead of financing a new one. Or save up the cash to buy your new HDTV instead of financing it through Best Buy. I think that’s the larger point here that is being missed by some due to Matt’s selection of an example that has many exceptions.
This is really a thought-provoking post, but might be too simplistic. I agree with what you are saying as a general rule, but with some exceptions. As far as financing day to day purchases (running up a credit card to buy groceries, gas or fast food), well… that’s just foolish (yet many of us do it every day).
Then there are more durable purchases but these are still depreciating in value. Think cars, appliances, furniture. I think this is where most everyone chooses to finance the purchase, one which can carry a lot of interest over the years of paying it off. Here’s where the emphasis on saving then buying should be placed.
Finally, there are asset-creating purchases. This includes buying a home, paying for a medically-necessary treatment that isn’t fully covered by insurance, or even investing in an education. If the expected outcome from purchasing this type of asset exceeds the cost of financing, then I say go for it.
Before I finished college I was earning just a few dollars more than minimum wage. For a full 6 years after graduating (until recently), I was earning several times that. I’ve run into a little bump in the road from a job loss but am still doing better than I was before having the sheepskin. I have no problem whatsoever paying the 1.625% interest on my student loans (and yes, I realize I got lucky by consolidating my loans when rates were low… still, the interest isn’t huge).
I think the smartest thing one can do is to take on the debt, but to continue living like a miser until the debt is paid off. Live like you’re earning $8 an hour even when you’re making $38 an hour and you will pay the debt off fast. You still get to earn much more even after you’ve paid your debt off. It’s also important to live within your means, so taking on a mortgage for a modest house is okay. Buying more house than you need is not.
Another vote for what DL said.
The same can be true of some other large purchases, I think. Suppose you’re buying a $10,000 car, and you can either finance it at 6% for 60 months, paying $193.33 a month, or put that money in the bank and buy the car with cash after 52 months (riding the bus to work in the meantime). With financing, you’d pay about $1600 in interest overall.
Now, suppose you live in a city with a great bus system, so owning a car would save you just half an hour of commuting every day. Over 52 months, you’d save about 563 hours of commuting, paying $2.84 per hour. If your time is worth more than that, then financing the car is a good deal.
I have to agree that you have missed the boat on your example. I can not think of any entry level job my son could get in Nanotechnology with out a college education. I also don’t think that your example would help much with anyone wanting to study Medicine or Dentistry.
DL says most of what I wanted to say (and more) very nicely. But I will add a few other factors.
Knowing yourself and your motivation is key to making decisions about college. Imagine a scenario where a person out of high school does manage to get a well paying job, maybe even with free rent of living at home. Does an 18 year old have the will power to save all that money? Perhaps. But perhaps not. Let’s imagine that this student does have the will power and they work and save the money for school. By the time the student has saved for school, she is gaining momentum at work and in her career. She’s making more money but in order to keep her job she needs to work long hours. Part time school would be 1 or *maybe* 2 classes a semester/quarter. That would take so many years that it seems pointless. So does she quit her job to take a lesser paying part time gig and go to school? Maybe. Maybe not.
I do actually think that taking some time off between high school and college can really help give you perspective and improve your college experience. But you have to know yourself and your goals.
And on top of what DL was saying above about the financial considerations, also consider that student loans tend to be really cheap loans. I have 35K in student loans from grad school that has an interest rate of 3% and is payable over 20 years. And student loan interest is tax deductible, even if you don’t itemize. Also, it’s easy to defer student loans (with no credit rating hit) if you need to. As far as I can tell, it’s the best kind of loan to have.
I like the idea that you should save for what you buy, but life is often time sensitive. I bought a camera when my daughter was born and paid for it over the next 6 months. That was definitely the right choice. I once bought a car (with a loan), which allowed me to get to work. Also, the right choice.
So, as you said, consider your future when you open your wallet, but don’t get stuck behind a line you put in the sand.
I’ve got to agree with DL on this one. You’re forgetting opportunity cost.
Even at an entry level job straight out of college, I was making $18/hour versus $10/hour at a college internship (part-time) through my last two years of college. I would not have been afforded this internship had it not been for completing two years of college education. Prior to the internship, I was making $7/hour at a catering gig (also part-time). To say I should have avoided debt to continue working at low pay to save for an education isn’t valid. I would have been rather foolish to skip college on account of having to pay for it later.
Also consider that working full time and attending class at 12 credits (or less) / semester may not qualify you for specific aid or benefits afforded to only full-time students. Plus, consider the cost and toll that takes on YOU with trying to keep your marks at a satisfactory level.
It all comes down to opportunity cost. If going to a more expensive university may afford you a higher salary, then by all means pursue it. If the loan payments upon graduation will put you in over your head, THEN consider a more budget-friendly university or seek assistance through scholarships, military service, or work programs. Simply not furthering your education because you don’t have the full amount saved in the bank is wasting a lot of opportunity.
Matt,
I hate to say this, but you used a piss poor example to make your point. There are two significant economic concepts that you avoided, but they are critical in this example. In addition, you made assumptions/exaggerations to support your opinion, without regard to reality.
In no particular order… you assume that a college student who takes out loans will not work during school, thus coming out with no experience. Really? Do you think students borrowing money don’t have internships, co-ops, or relevant work experience?
Next: What type of low-level job do you think a high school graduate can really find in his area of interest that is actually considered relevant work experience? Sweeping floors? Cleaning? Filing papers? Data entry? Answering the phones? That’s not relevant work experience, and I can’t think of many industries where you can get hired without a college degree anyway. Being in college generally exposes one to a formal co-op program with legitamate work experience.
Third: As a high school graduate, you’re making $10/hr or so, if that. How much are you really saving for your education? You’ve got rent, food, a car payment, insurance payment, gas, utilities…
Fourth: I don’t think it’s realistic to expect a student to work full-time AND attend classes full-time. It’s tons of work and few people do it. When you consider this, a four-year degree becomes an eight-year degree. (And since most programs are 120-credit hours, you’d have to go to summer school to graduate in 8 years. Otherwise, at 12 credits/year, you’re looking at 10 years of school!)
Most colleges and universities give full-time students a tuition break; usually, once one pays for 12 credit-hours, the next 6 are usually free. As a part-time student, you’d have to pay full price for every credit hour you take. A full-time student paid for 12 credit-hours; in this scenario, a part-time student paid for 18. Then, you also have to consider that tuition is rising faster than inflation every year, and your $10/hr entry-level job sure isn’t.
Fifth: You have to consider opportunity costs. In the scenario I outlined above, you have a student who is spending 4 additional years in school, earning a whopping $20k/yr, probably with few benefits. Depending on the field, that student could be making more than $40k/year if they had their degree! Over 4 years, that’s $80k that they are missing out on.
You might ask, so what about the interest payments on that pile of student loan debt? Doesn’t that shoot all of that economic reasoning out of the water? No. One vastly under-used and under-rated principle is that of Net Present Value. If you think about it, a dollar today is worth more than a dollar tomorrow, no? Wouldn’t you rather spend in today’s dollars and payback in tomorrow’s dollars? That’s exactly what happens if you are able to borrow at 0% interest. But even if you can’t, there has to be some interest rate at which it is cheaper to borrow than it is to pay it back, right? Well, that’s what an NPV calculation does — it evaluates the value of a series of future cashflows in today’s dollars.
In my case, I have a total of $80k in undergrad and graduate student loan debt. I figure over the course of 20 years, it’s going to cost me $60,000 in interest — for a total amount of $140k to be paid back. Using a discount rate of 2%, the true cost of my student loan interest in today’s dollars is $34k. When you figure that you’re missing out on $80k in income because you’re still in school when you could have borrowed the money and graduated, borrowing the money is a no brainer.
Sorry dude, but this example misses the mark.