On the face of it you can, because there’s the money in the bank that’s maybe not doing much. After all, the bank is paying you 0.00001% on your deposit account, you don’t understand the stock market so there’s no point risking it there because you could lose a lot more than whatever you’ve seen in the shop will cost you. Why not treat yourself?
But do you have a financial plan?
Honestly, if you don’t have a financial plan, you’ve absolutely no idea if you can afford that new thing or not! Absolutely none!
Let’s go back to basics
You want to have a certain amount of money and assets by a certain age. I would suggest at least $1M by the age of 50 including your house, pension plans and whatever as a minimum. For a couple, it’s at least $1.5M.
Work back from there and figure out how much you need to save every month to get there.
If you’re 25 years old, you need to be socking away $500 every month for the first year. The next year, $600 a month. The year after that, $700 a month, and so on, increasing your savings rate by $100 per month every year. If your savings grow at 7.5% a year, you’ll be a millionaire by 50. Just! And you’ll probably have to pay some taxes along the way on your investments…
Anyway, let’s assume for the moment that you’re saving in line with this plan and that you’ve been following it religiously for the last 3 years. This means at the age of 28, you should have about $25,000 in the bank or in assets, at the age of 40, you should have about $350,000 in the bank or in assets. Even this is the absolute minimum and unexpected things can happen along the way like being unemployed for a few months which might eat into your savings and prevent you from adding to them during this period.
The affordability test
If at the age of 28, you haven’t got $25,000 in net worth, you can’t afford it! And even if you can, you might prefer, having thought about it in these terms, to pass on that impulse purchase and to keep the money in the bank instead.
If you have a partner, it’s possible that, even though you’re focused on the long-term, your partner is more of the spend-it-if-you’ve got-it variety. If this is the case, it’s absolutely crucial that you have your numbers straight in your head to be able to push back against unnecessary purchases that would take you away from your (joint) financial objectives. And don’t forget that the numbers I’ve given are only for a single person, not a couple.
Having said all of the above, it’s important to have a bit of slurge-wiggle room in your monthly budget if possible to buy a few things that are not completely necessary. This will actually help you stay on track because otherwise you might simply throw the budget out of the window as being too restrictive and depressing.
You can only afford to spend any surplus you have after meeting your savings goals first. By thinking about your finances in this way, you’re well on your way to Simple Money Management!