Friday 2 March 2012

It Costs How Much?

The basis of the DIY Income Investor approach is to keep firm control of your expenditure. This might not seem like much fun - until you can retire early, that is!

Of course, you should be looking for the best value for all of your purchases - 'comparison shopping' and looking for discounts. Sometimes you just need to control the 'urge to splurge' and hold off the purchase decision. Once you overcome that urge to buy, you may well be innoculated against the spending disease.

So here is a useful mind-trick to help you make a decision about that next purchase.

The trick involves a bit of mental arithmetic: you need to work out how much you would have to save to earn the purchase cost in annual interest (or dividends).

Let's keep it simple and use a 5% interest/yield rate; this means you have to multiply the purchase price by 20. A mental shortcut is to double the price and add a zero.

So something that costs £5 (or $5) would require: 5 x 2 x 10 = £100 (or $100) in the bank to generate the same amount of interest over a year. How much effort would it be to save £100 ($100)? Not negligible, is it?

Try a bigger purchase, say a new TV for £400/$400. That purchase price would be equivalent to the interest on 400 x 2 x 10 = £8,000/$8000. How much effort would it be to save that amount of money?

Once you have grasped this simple conversion logic of purchase price versus interest equivalent, a sobering truth hits you: NOT buying something is equivalent to saving the 'dividend-equivalent' lump sum.

And that will lead you to discover the true saving in avoiding recurrent expenses. If, for example you find you can do without something that costs, say, £5/$5 a week. How much is that worth in terms of an equivalent lump sum?

The calculation is: 5 x 52 x 2 x 10 = £/$ 5,200! Worth having (if only theoretically).

Do let me know if this helps your budgeting!

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. I like the dual emphasis on investments and expenditure control - these approaches are rarely combine because they require thinking about different things. Your trick is a worthy attempt to combine them ... though it works best for recurrent spending and is best seen as a means to *avoid the need to save* the equivalent amount.

  2. This is a nice little trick and something I sort of already do occasionally. The only problem is that it is addictive!

    The compounding affect of dividend income makes it impossible for me to use/spend any of the income. When I think about using some of the income, I find i calculate the opportunity cost of losing the compounding effect which puts me off spending it!

    I say i'm a wise investor, my wife just says i'm tight!

  3. I've actually been using this system myself for about a year now. And a a direct result my spending has decreased significantly and my available funds for investing have increased too. So it's a win win situation.

    My system is slightly different though, as I also factor in how much money I would have to earn (gross).

    So using your example of the TV purchase, not only would I have to save £8000 in order for the interest to pay for the TV, but I'd have to earn approximately £12000 before income tax and N.I. In order to have the £8000 in my pocket.

    1. Wow! How can you bear to spend anything! Well done.