Monday, April 4, 2011

Recurring Expenses Will Bleed You Dry

A colleague forwarded me this article in the WSJ entitled "ROI: Is the iPad 2 Really Worth $2,000."  In it the author realizes that when he uses his capital to buy the iPod, the capital is no longer available for investing.  Consequently, the cost to him is not only the $500 up front cost, but all of the return that he would have made on the invested $500.

However, far more important is the insidious impact of recurring expenses in in drastically reducing the amount of money that you will have available for retirement.  For example, consider a $100/month cable bill - if the money was instead invested (even at a fairly conservative rate of 8%) then after 35 years you would have $100,000.

A $400/month car lease?  $400K after 35 years.  A $50/month telephone bill? $50K after 35 years. So what do we do about these recurring expenses?

Avoid Recurring Expenses
Basically, you should try to avoid recurring expenses whenever possible.  Do you really need cable when you can watch TV on the Internet or broadcast for free?  When you can borrow movies from friends or even use the library?  Even a Netflix subscription would cost a lot less.  Also, can you avoid Starbucks by drinking the coffee at your firm?  Is the firm's coffee really that bad?  Maybe you can just buy some decent creamer to mix in the firm's coffee?

Watch Out For Hidden Recurring Expenses
However, some recurring expenses are hidden where people can't always seem them.  For example, buying a larger house means increased recurring expenses for mortgage interest, increased taxes, and increased assessment or lawn maintenance.  Also, the taxes and assessment typically go up over time.

Put It Towards The Loans
Alternatively, for the more recent law school grad, instead of aiming for retirement, these additional savings could go toward paying off the student loans.  Although retirement may seem too remote to a person in their mid-20s or early-30s to motivate a change in a behavior, just about every new grad starts chafing under the yoke of student loans very soon after starting firm work.  Which is going to make you feel better -  more TV options during the few hours you get to spend at home or getting free of your non-dischargeable indentured servitude months or years faster?

Try Delaying It - Even Just a Little
Sometimes people think about going without a luxury like cable for 35 years and their minds instantly rebel.  The 35-year time period is just too long for them to think of depriving themselves, so they just start spending now.  However, recognize that if you can just do without cable for one year - one stinking year - and instead invest the $1200 at 8%, then you will have about $17,740 in 35 years.  Consequently, even one year's delay can add up big on the back end. 
One way to delay the onset of the recurring expense is to use it as a reward when you have accomplished something.  For example, no cable subscription until your student loans are paid off.

In summary, take a look at your monthly expenses - are there recurring expenses that you could cut?  Every $100/month that you can cut out is $100K more in 35 years - or alternatively, means freedom from student loans months or years faster.  Good luck!


  1. This is a deceptively tricky subject. One of the greatest pitfalls in giving personal finance advice is separating "wants" from "needs." You can't authoritatively state that person X is better off foregoing cable for life than working for two (or ten) extra years, unless person X is you.

    All else equal, a person with less costly wants and needs is wealthier than one with more. It's also true that not everyone can earn enough to satisfy their needs, and a decision must be made to give something up, either nor or in the future, or both. However, there seems to be a self-serving belief among personal finance correspondents that most people are unaware of the choice between current and future consumption, whereas I believe that people implicitly understand the tradeoffs and make rational decisions.

  2. 11:20 - Interesting comment, especially with regard to rational decisions. With regard to awareness, I have known many people who did not connect the dots with regard to how much a monthly recurring expense was really going to cost them in the long run. People seem to think in terms of how much money they have "right now" and the value of the money with compound interest applied is often not the first thing on their minds.

  3. 8% interest is NOT conservative... Many people would be quite happy with that level of annual return. Thus, your numbers are over-inflated. I'm sticking with my cable TV.

  4. Not only is 8% arguably a high figure, but inflation means that the hypothetical sum isn't worth as much as it sounds. Still, I'll add this to the list of reasons to never donate to my alma matter.

  5. 6:11, 12:33 - Interesting.
    Here's a link to a Charles Schwab website with regard to long-term planning

    As you can see, the long term return of large cap stocks has historically been 10%. However, Schwab estimates that the 10-year forward-looking return will probably be more like 8%. They seem to reach this conclusion primarily based on an assumption of lower inflation for the next 10 years. If inflation is higher, total return will be higher.

    I suppose that anyone's prospective return depends on their portfolio, but a reasonable 10-year return for large caps seems like 8%.

  6. 8% *real return* is pure fiction.

    That would imply doubling in 9 years. Does the economy really double in size every 9 years? Twice the houses, cars, appliances, medical care, lawns mowed, etc? Of course not.

    Much of that return is made up of inflation and the survivorship bias of stock market indices, which drop unsuccessful companies from the index and only retain the winners.

  7. @10:31: I don't think there's anything wrong with investing in index funds to take advantage of survivorship bias, especially considering that survivorship bias is exactly why stock market indices perform so well over time.

  8. a slightly nit-picky comment, but I can't believe the WSJ would miss this. There's a difference between "price", "cost" and "worth."

  9. I know this post is over 5 years old, but I couldn't help but enjoy reading this article from Managing Partner and then seeing an anonymous poster complain about an 8% return being "pure fiction" and so therefore they were going to keep their cable bill.

    Talk about missing the forrest for the trees. If you had cut $100/mo from your budget at an 8% return today you'd have $7600. If you had only received 4%, you'd have $6750.

    When you're getting started, your rate of return is almost irrelevant. I don't know why so many people focus on it. Your savings rate is much more important.

    I'm certainly happy to take $6K over $0K, but to each their own.