A LOT OF INK HAS been spilled over young people’s spending decisions and the impact on retirement savings. Whether it’s a latte or a lunch out, the thinking goes, we all spend money on daily trifles that rob us of a much greater sum in the future. Back in 2019, Suze Orman made headlines when she likened a daily takeout coffee habit to “peeing $1 million down the drain.”
I’m sympathetic to this line of thinking, which is based on solid time value of money principles. For financial planning enthusiasts like me, time value of money calculations can be a lot of fun.
I recall getting my first financial calculator at age 34, which I promptly employed to badger my little cousins. Every time they bought something, I told them how much that money would be worth if they just invested it for 30 years and earned a 10% compounded rate of return.
They rolled their eyes and tuned me out. Turns out it’s hard to get 20-somethings to think about their lives 40 years in the future. Go figure.
But there might be a better way to talk about spending decisions that makes them feel more tangible, no matter how old we are: by talking about the pretax cost of our purchases.
We make purchases with after-tax money. That’s true whether we’re buying breakfasts, taking trips or making mortgage payments. To afford anything we buy, we actually need to earn more money than the sticker price shows. For example, if we pay 30% in federal and state income taxes combined, a $2 coffee costs $2.86 in pretax income, a $10 lunch costs $14.29, and a $50 night on the town costs $71.43.
Once we understand that lesson, we can better compare our spending costs with our pretax income. That’s helpful for those of us who are salaried workers. If you’re like me, you can rattle off your salary without thinking about it, but it’s harder to remember your take-home pay.
Another advantage to this approach: It deals with the reality of current earnings, rather than the distant future. That can be especially helpful for younger workers. A 23-year-old working his first job will likely have a better grasp of the money he’s making today than of his potential net worth in 30 or 40 years.
I don’t have much of a Starbucks habit, but I have other expenses. In July, I traveled to Costa Rica with my fiancée to celebrate our engagement. The trip cost me $2,000 of after-tax money (or 400 lattes, for those counting at home). Assuming a 30% tax rate, I needed to earn some $2,860 in pretax income to pay for the trip.
For illustrative purposes, let’s say my annual salary is $68,600. In that case, the trip to Costa Rica would have cost 1/24 of my yearly earnings, or half a month’s income. If my salary is $34,300, the trip would have cost a month’s income. I likely would have made the trip no matter what. Still, knowing I had to work for an entire month just to cover the cost would have made me consider the expense more carefully.
My belief: We should spend and save money in ways that reflect our values. By grounding these decisions within the real cost of our time and labor, I think we can help others—as well as ourselves—get closer to this ideal.
Matt Trogdon is a financial advisor in Washington, DC, with a special interest in helping Gen X and Gen Y families. He also serves as a workshop instructor for the Babson College Financial Literacy Project. Follow Matt on Twitter @Matt_Trogdon.
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Thanks for your article. As I’m sure you know, many of us older folks have criticized the spending and savings habits of those in the younger generations. I would appreciate your views on the financial habits of Gen X and Gen Y families and whether you think the criticisms are warranted.
IMO statements about generational habits and practices–unless they can be backed up with *reliable* statistics–overgeneralize, and tend to become projections of our own minds.
“It is the tragedy of other people that they are merely showcases for the very perishable collections of one’s own mind.” – Proust
You bring up some good points. I only know Suze Orman by reputation, but I hope your advice for Gen X and Y is better than her “click-bait” headline. I can’t imagine someone dutifully setting aside $100/month and putting it in a Roth account for 40 years. And tell me where I can get a 12% annual return for 40 years? The younger generation need practical advice which I’m sure you give. I know I’ve spent money foolishly from time to time in my life, but I’ve always saved and paid my self first along with living below my means.
This is an excellent way for taxpaying consumers to gauge the real cost of their purchases, whether frivolous or necessary. Thank you.
I used to equate spending with how many hours I worked to pay for something. The only horse race I went to (in the early 70s) cost an hour’s work and I lost a couple of bucks betting on a sure win tip from a “former friend 😂”. I likely worked several hours for that outing and would have gotten more enjoyment elsewhere or by saving!
Nice article Matt. I like to think in terms of hours worked. I used to stop at a local deli for coffee and a breakfast sandwich on the way to work. It was next to a gas station, and it got lots of construction and landscaping crews stopping there. A lot of the workers would buy a days worth of breakfast, lunch, bottled water, Gatorade, and snacks.I would quietly estimate they were spending 2 hours of hard work, after taxes, on food for the day.
I used the hours worked theory for decades. After all my deductions, including my 401k, my net pay was about 50%. It was easy to do balance test. Was I going to get enough enjoyment or had a need for something to work 10 hours for or a quarter of my week? You realize that those “needs” were really “wants”.
Thanks, Rick. I think the “hours worked” view is spot on. I wish I’d thought of it myself 🙂
I think we’ll get a lot farther teaching young folks the value of their money if we make it more tangible. “You make $20 an hour? We’ll you’re going to have to work two hours just to pay for your (insert item here).”
Thanks for reading!
As one of those who has spilled a lot of ink on wasting money on HumbleDollar and other blogs, I like your way of looking at it. It certainly makes the point.
On the other hand “spending and saving money in ways that reflect our values” seems to be part of the problem for many people.
Ones values are nobody else’s business – until you become a senior with little savings, living on SS and demanding all the more you deserve and are entitled to.
Many people claim their right and freedom to do what they want, including spending their money, even choosing to go uninsured for example and yet there is virtually nothing an individual can do that sooner or later does not impact others.
You’re saying nothing more than that people that don’t act wisely impose a cost on themselves and society at one and the same time. People that don’t see or don’t care about imposing penalties on themselves won’t see or won’t care about imposing them on society too. It’s ever been thus.
I find communitarian assumptions very unrealistic. They tend to nullify themselves. Perhaps others have heard someone say “this isn’t good for me but I don’t mind because it hurts no one else”, but I haven’t. People justify what they do–right or wrong–for the sake of themselves and others at the same time. “It doesn’t hurt me and it doesn’t hurt others.” Or perhaps, “I know it hurts me and I’m trying to stop, and if I can it’ll help my family/friends (and implicitly society) too.
So telling people to do better for the sake of others assumes being a good or better person is a public awareness problem about a wider impact. That’s true of young children that might not truly understand the consequences of hitting Susie with a book for playing with their toy. For adults not so much. That people don’t know what they do affects those around them and society to one degree or another I think is a sketchy but now popular communitarian idea, borne of the struggle to understand disagreements over norms by imposing a simplifying explanatory narrative about beliefs of folks with whom we don’t agree.
That’s a great point, and one I hadn’t considered. I was thinking more along the lines of, “if you say you value travel, then you should spend more money on travel and less money on fancy clothes.” But we are definitely seeing the societal effects of individual choices these days, aren’t we?
Thank you for reading!