Note: This is part 5 of a 5-part introduction to financial independence and understanding. Make sure to read the whole series to really grasp what Money Tofu is all about!
If you’ve read about the 3 reasons to achieve financial independence as well as why trying to do so is not worth it, you may have decided either to pursue FI or not. I’m here to tell you that regardless of whether you decided that FI is your goal, you will still benefit from having a high level of financial understanding (which Money Tofu will hopefully help you with).
For those seeking FI, financial understanding is extremely important so you can build a realistic plan that will take the money you earn, save through smart investing to generate even more money, and spend less on wasteful things that distract you from the end goal.
For those not seeking FI, financial understanding is equally important so you can maximize the the worth of the money you earn, save enough to not have to worry about emergencies, and spend on all the right things that truly bring value to your life.
It’s about maximizing what your money gets you
Having a goal like FI helps you to focus your money management strategies for that purpose, giving you a heuristic with which to make decisions. Does spending this money now bring me closer to FI? If so, proceed. If not, re-consider whether it is worth delaying the ultimate goal.
The same type of thought process can be used without FI as the goal. However, you need another goal in this case: the goal of maximizing the value of your money.
Money, or at least the concept of a currency that you can trade for goods and services, is finite. Nobody has an infinite amount of money (and if the government were to start printing money haphazardly just to increase the supply, its worth would disappear, making it useless).
It is precisely the fact that money is a scarce resource that we need to think about how best to spend it. Well, that’s obvious, you might think. And you would be right, but many times, we don’t think carefully about spending money on impulse, leading to poor use of the money we do have.
Suppose you had $100 and there were 2 items you could spend it on:
- Item 1 costs $20 and gives you 10 happiness.
- Item 2 costs $25 and gives you 20 happiness.
How would you spend your money? A rational person would try to maximize happiness per dollar spent. For that $100, if they purchased 5 quantity of item 1, they would gain 50 happiness. If they purchased 4 quantity of item 2, they would gain 80 happiness. Clearly item 2 is the better buy!
But of course, if we buy item 2, that means we have spent that money and cannot use it for item 1. Since item 2 results in more happiness per dollar spent, it’s a good trade off, but a trade off nonetheless.
This extremely simplistic example illustrates that if we think about the resulting value that spending money gives us, we can maximize the value of what we spend.
Needs vs. Wants vs. Alternatives
How can we look at our spending patterns and look at the end result that they provide us to effectively maximize our money’s value? Consider the following somewhat simplistic scenarios.
Scenario 1 – Necessity: You have run out of toilet paper and need to buy more. You visit the store and find 2 packs of toilet paper for sale that are identical in brand, quality, and quantity. They are literally the same items, but item A is listed at $10 and item B at $20. Which item do you buy?
Scenario 2 – Coffee: On the way to work, you like to get a cup of coffee from a chain coffee store. It just so happens that two of the same stores opened next to each other on the same street. One of them is having a sale, offering your favorite coffee for $2 while the other store offers the same cup for $4. Which store do you go to?
Scenario 3 – Commute: You drive to work and pass through a toll bridge everyday that charges $3 each time you cross it, making for a 30 minute commute. Recently, an alternative toll road opened up that will take 5-10 minutes longer each way, but it only charges $2. Which route do you take for your commute?
The scenarios above outline 3 different problems and thought processes you should have.
Toilet paper is a necessity; you can’t do without it, so the choice you have is not whether to buy it, but for how much. Unless you are trying to throw away money, the logical choice is to buy item A for $10 instead of item B for $20. Easy choice for an easy situation, right?
Coffee, on the other hand, is a “luxury,” a want rather than a need. Unless you have a medical condition that requires you to drink coffee, you will still live even if you did not. That’s why this scenario actually offers a 3rd choice: don’t buy coffee at all. Even better than saving 50% is saving 100%, right?
Actually, there is a 4th choice in the scenario above: create an alternative to buying ready-made coffee from a store by brewing your own coffee before you leave the house! Whenever you are dealing with a want rather than a need, think of the alternatives that could satisfy your want just as well.
Commuting is a trickier thing to balance. It is a necessity (unless you can work from home or are already FI), but there are also alternatives. The key is in identifying which part is the need and which is the want. The necessary part of commuting is getting from one place to another; the want in the scenario above is driving to do it. Viable alternatives could be taking public transportation, biking, or even walking if the commute is short enough.
So what do these things have to do with maximizing the value of your money?
If you really think about everything you spend money on and analyze whether it is a need or want, and if there are alternatives that can give you just as much value, that will ensure you make the right spending decisions that bring you the most happiness.
A person who stocks up on toilet paper whenever there is a sale, makes their own coffee each morning at home, and commutes by taking the bus may be just as happy with those 3 choices as someone who buys toilet paper regardless of price, buys a cup of gourmet coffee each morning, and spends thousands of dollars on tolls and gas each year. The difference is that the first person has that extra few thousand dollars more to spend on other things that bring happiness.
Maximize your happiness with Money Tofu
If you noticed, maximizing the value of your money is applicable regardless of whether you are pursuing financial independence or not. True, being FI can make you much freer and generate happiness that way. But even if you decide not to chase the freedom of FI, you should still want to maximize what your money can do for you and its effect on your life.
We talked a lot about spending in this article. Spend is 1 of the 3 keys to financial understanding (along with Earn and Save), and it is also the one that ultimately drives your motivations and goals. After all, what is the purpose of earning and saving money if not to ultimately spend it? However, having a deep understanding of how best to spend money to generate happiness is what separates someone with financial understanding from someone without.
Spend: How you spend money is the easiest and quickest of the 3 keys to adjust; you only need to identify your current spending and make some tweaks. You can do this on an item by item basis if you look at what your regular spending habits are, possibly starting with the larger ticket items for more impact. Money Tofu will help you with ideas and practical methods you can apply to lower your spending while raising your happiness.
Save: How you save money is also easily adjustable, although it takes some more knowledge about the variety of investment and savings instruments being offered by financial institutions. It also needs more mathematical analysis to truly understand the right way to save to achieve your goals. Money Tofu will help you navigate these financial mazes with easy-to-understand recommendations and solid investment techniques.
Earn: How you earn money is the least changeable of the 3. Neither finding a better-paying job nor starting your own business to generate income are easy. However, if your current level of earnings isn’t enough to reach your ultimate spending goals, then you should make an effort to improve earnings. Money Tofu will help you with analysis and resources to maximize your earning potential.
Thanks for reading this introduction to financial independence and understanding. Continue your adventure by checking out the rest of Money Tofu!