Our journey to Financial Independence

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How Much Can You Really Afford?

No matter how hard we try to save… Society is built on spending. From the roof over my head to the food on my plate. Everything comes at a cost. The only way to be free of expenses is by living off the grid. Then again that isn’t feasible for most of us.

So how much can you afford? Truly… It depends on who you are. The principal of the Financial Independence Retire Early (FIRE) movement is to maximize income and minimize expenses. Optimizing your saving rate to achieve freedom in x amount of years. 

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Even if FIRE isn’t your cup of tea and you just want to set a few dollars aside. There is one inevitable question. Can you afford it? Having the exact amount on your credit line or on your checking account means nothing. 

So what is affordable and why can you afford less than you think?

What does affordable mean?

Affordability is often only taken into account for big purchases. For example, the bank will calculate your affordability before allowing you to mortgage a home. You might also give more thought to a car purchase as it’s a milestone. 

Yet, we often overlook the affordability of everyday items. How many beers can you truly afford? Or a phone plan are you sure you can afford it? The biggest culprits are monthly payments and 0% financing. They insidiously increase your expenses.

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What is $20 more a month for a brand new TV! It will completely change your life, 8k is the new thing. On the other side, your monthly expenses have increased for an asset you won’t own for another 47 months. 

Understanding what you can truly afford is the key. Are there any rules? Not really. It’s up to you to find the best system and stick to it. To help you in this journey and avoid living paycheck to paycheck: this article will go into each type of expense and give a rough idea of ratios.

Let’s break it down into 3 categories: Transportation, Lodging, and leisure.

How much transportation can you afford?

Transportation covers as much a car as a commute. Are you truly making the most of your salary if most of your time and money is sunk into your commute? Let’s take London as an example cost of life overall is extortionate and living centrally on an entry-level salary is challenging… A yearly railcard costs over £2600/pa. 

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The cost of transportation therefore not only factors into a new car but into your choice of work… If you were to move out of the city center the savings on rent might be offset by your commute. Not only will it cost you financially, but your time will also disappear into the back and forth. 

How about a car? People tend to think their car is their business card. That it’s something they will be judged on. So much so that in the USA the median cost of a new car is $40,573 with the average buyer borrowing $35k. The median average salary in the States is $49,724… 

More than half of the yearly income went to buying or borrowing to buy a car. Without taking depreciation into account it’s a significant hole to put oneself in. As this doesn’t cover insurance or taxes. My friend Yasi from Fast Track Life makes a great case for the hidden costs of a car in her article “The Under Estimated Costs of Owning a Car”.

I personally don’t own a car but I have been on the prowl for a new ride. I’ve decided to apply Andrei Jikh’s idea of no more than 10% of my annual salary. The car won’t be anything fancy but it will get me from A to B without bankrupting me! You can discover his video below:

Just because you can pay for it today doesn’t mean you can afford it. Remember the long-term implications and how it will tie you up. I explore this more in-depth in “5 Ways To Stop Living Paycheck to Paycheck”.

How much housing can you afford?

Whether it’s buying or renting you are going to need to pay to get a roof over your head. Of course, you could go off-grid but even that would cost up front and still need to be factored in. 

Renting

I won’t delve too much into buying versus renting as that will be the object of a future article. I for one rent in London, England. The way my girlfriend and I have approached it is our share of the rent can’t be higher than 33% of our net monthly salary.

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This was a big factor when deciding to move to the UK from my native Switzerland. I explore more of it in “Should I Live Abroad?”. It allowed me to get started with the 50-30-20 rule. In which you should spend no more than 50% on needs which include energy, food, and shelter.

I decided to stick to 33% at first for our rent as it allows me to set aside 40%+ of my income monthly. Since then, we are looking to increase our income and take the cost of shelter below 30%. 

Would we like a new fancy flat with a gym etc? Of course, who wouldn’t? The problem with this is it inevitably leads to Lifestyle inflation and an infinite circle of loss.

Buying

I’m yet to acquire my first property as I value geographical flexibility highly. But there are a few things to keep in mind. The goal of a Bank is to loan you the highest amount of money that you can afford. In this case, it would be as little as making ends meet. 

Having saved up the exact amount of money for a deposit is risky. It leaves you with no capital for unforeseen costs and taxes. You might be a homeowner but a mortgage can set you back.

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Old school sources would recommend you only by property worth 4.5 times your annual income. It would give you a strong ratio of debt to equity. I would personally always look to a mortgage when the interest rates are as low as today. You have a high chance to make a higher return by investing the remainder of the sum.

There are many reasons to invest in real estate as long as you can cover your cost. Check-out “Real Estate Investing: The 3 Edged Sword” by Plant Money Seeds for an in-depth look.

How much fun can you afford?

There is less of an absolute side here. Of course, some will tell you to stop drinking your Starbucks or getting a pint after work. But these are not the reason your portfolio isn’t growing. Leisure expenses can become insidious.

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Whether it’s spending a few thousand on a holiday or a new phone can you afford it? My rule of thumb here is if you were to spend twice as much would you still get it? This gives you a healthy mindset towards spending. 

Most importantly, will you need to go into debt for it? There is absolutely no reason to get into debt for a want. This is where monthly payments pile up. We all know about Credit Card payments and how easily you can overspend. 

The positive side of Credit Cards is that they immediately show you how little you can afford. On the other hand, the new financing options lead you to spend more than you should. 0% APR and only £75 a month! What a great deal for the new iPhone. Yet, when you add it to the new TV payment, your car payment, and all the other “bargains”. You end up starting the month with 90% of your income dedicated to fixed expenses. 

Time to spend

Here’s the bottom line… we are going to keep spending money. No matter what we think we will. The trick is to understand how much we can truly afford and let our money grow around it. 

For mid to long-term goals investing is a great solution. It allows you to fulfill your “buying” urge but put your money to work. Of course, if you are going to need the money in less than 10 years going to the high-yield savings account is the way.  

If you want to start your investing journey why not find out which investor you are and start off with my article “Trading 212 or Vanguard? What investor are you?

What are your tips and trips to figure out affordability?

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1 Comment

  1. Really insightful read – as a general comment on the opening, we are a society that functions on people getting into debt rather than saving. Think was evidenced by UK lockdowns when everyone started saving money so there was a rush to open up again.

    I experienced the cost of cars when I sold mine and started sharing with my wife and having a couple extra hundred!

    I don’t get too trapped in luxury purchases like TVs and only buy these outright to avoid bleeding extra cash every month.

    For my mortgage when I got it my salary was about 6.5 ratio, though have had a few promotions so now it’s more like 3.5 so not so bad!

    Great post 🙂

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