Little Rhett’s Corvette (Baby, You’re Much Too Fast), or: How to Spend Like a Millionaire (Part 1)

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Last year was a great one for Rhett. He graduated cum laude from Pepperdine University and landed a job with Boeing as an aerospace engineer, making $62,000 a year.

He rents an apartment in Redondo Beach, which he shares with a college roommate. He’s well on his way. To celebrate his accomplishments, he bought himself a new black Corvette Stingray with the performance package that costs $61,395. No wife. No kids. I worked so hard in school for this,  he thinks.

He moved too fast. That one decision moved him from a position of strength to weakness.

As math oriented as he is, Rhett missed some key numbers that would have helped him make a better decision.

Last year was a great one, but because of his decision, next year and the years after won’t be close to being as great as they could be. And because you’re reading this, you’re not going to make the same mistake.

I’ve spent the last few posts discussing the reason for and power of giving as well as passing on financial and true wealth. That’s nice, but what if you don’t have any money to give or pass on? Today is the start of a series on how to make that money, starting with the simple (but seemingly contradictory) math of making money through spending.

“How Much Car Can You Afford?”  

While some online calculators may show that he can afford the $1,200 a month Corvette financing payment, it only leaves him with $75 a month afterwards. He’s just a round of beers away from being in negative territory (He better hope none of his friends have a destination wedding coming up!).  He should be buying this Corvette when he’s further in his career, making and saving much more than he does now. He’s trying to accelerate by some years, moving much too fast.

What happens if he leases a $33,000 BMW 330i instead? He reduces his car payments by about 2/3. Very nice, but it gets even better when you  see what it does to his savings. It goes from $75 a month to $846 a month, or increases by almost 11.3 times!

$ Monthly Corvette BMW 330i
Gross Pay $5,167 $5,167
Net Take Home 3,575 3,575
less:
Rent 1,500 1,500
Car Payment 1,200 429
Food 600 600
Misc. 200 200
Savings $75 $846

Compounding His Error

The mistake compounds. To do a quick-and-dirty on the long term effects of his decision, we double the savings every decade until he retires. We double because of the Rule of 72, which is a quick way to see how fast money will double at a certain rate by dividing 72 by the rate of return. Using the historical S&P return of ~7%, you get approximately 10 years (72 / 7 = ~10) before it doubles. So if Rhett is 22 years old and his first year annual savings is $900 for the Corvette ($75 x 12), double it to see what it would be worth at age 32. Then double again to see what it would be like at age 42, and so on and so forth until you’re around retirement age. You’ll see that it grows fast in the back decades. (This magnification is called Compounding, and it is the foundation for how I think about finance)

But Rhett owns the Corvette for 5 years. Take that retirement age and multiply it for every year he owns that car. Let’s compare how it looks if he buys the Corvette vs. the BMW 330i:

Corvette BMW 330i
Monthly Savings $75 $846
Annual Savings $900 $10,152
Age 32 $1,800 $20,304
Age 42 $3,600 $40,608
Age 52 $7,200 $81,216
Age 62 (A) $14,400 $162,432
Years Car Owned (B) 5 5
(A) x (B) $72,000 $812,160
Net Worth Difference $740,160

Huge difference. He 11x’s his money just by “settling” for the BMW.

Piling on here–what it would look like if he just bought a used car? (Conversely, imagine if his friend did have a destination wedding? Rhett’s $75 a month isn’t enough to afford the airfare or hotel, so he “buys” it using his credit card. In this case, the compounding effect goes negative and scary.)  Just for fun, let’s see what happens if he buys a used Toyota for $5,000.

Corvette Used Car
Monthly w/o Car $1,275 $1,275
Annual Savings $15,300 $15,300
Annual Car Cost 14,400 5,000
Savings after Car $900 $10,300
Age 32 $1,800 $20,600
Age 42 $3,600 $41,200
Age 52 $7,200 $82,400
Age 62 (A) $14,400 $164,800
Age 63 (B) $14,400 $244,800
Age 64 (C) $14,400 $244,800
Age 65 (D) $14,400 $244,800
Age 66 (E) $14,400 $244,800
Total Effect (A+B+C+D+E) $72,000 $1,144,000
Net Worth Difference $1,072,000

This one choice was the difference in whether he has an extra million or not by the time he retires.

If he buys a used car, he only has 1 year of car payments. That means years 2-5 of car ownership amount to about a $1,000,000 difference (B-E in the chart carry the non-car payment savings through the same period of time as A). Along the way, if he really wanted a shiny new Corvette? By the time he’s 32, he would have more than enough to buy 2 Corvettes (remember: $10,300 compounded 10 years + $15,300 compounded 9 years + $15,300 compounded 8 years + $15,300 compounded 7 years + $15,300 compounded 6 years = ~$120k).

3 Simple Ways to Spend Your Way to a Million Dollars

  • Do not mistake can for should. Just because some calculator or lender tells you that you can afford something doesn’t mean you should. And to help you decide whether you should…
  • Look below the line. This is the weakness of online calculators. They show you inputs “above” the line but they all miss the most important datapoint to help you make your decision. You should look below the line (basically your savings) to see the true impact, and if they don’t provide it, calculate it yourself using the online calculator numbers. In this case, a 2/3 reduction from a Corvette to BMW led to an 11-fold increase in savings! This is called “operating leverage” where a reduction in your fixed costs–called SG&A–can result in much greater cash flow.
  • Do the mental math quickly. Forget all the fancy online calculators–most of the time you need to make a decision on the spot. Just compare bottom lines and double every 10 years until you retire (which means you should know what your current bottom line is–I will teach you a better way to budget in upcoming posts). I wouldn’t do this for every dollar or else you’ll drive yourself crazy. If your budget’s bottom line is $10,000 or less, I would do the math for any expense over $100. If your bottom line is above that, then set your threshold higher.

How to Teach it to Your Children (Recommended for Ages 5+)

  • Your child has money from his or her lemonade stand. Now, how to spend that money? The concept of spending less than what they have is going to be new. What you’re really teaching them is the concept of scarcity, and because of it, not spending today means more options for later. You are teaching them to defer.

What I’ve Done: “You have $5. A hair band costs $1. So you can buy 5, but do you really want 5?” Sometimes they choose yes. I suggest letting them do it. Then right afterward, without any warning, take them to an ice cream parlor and buy yourself an ice cream using cash (using a credit card will confuse the message). If they’ve spent all of their money, as lovingly as you can, say, “Sorry, you spent all your money on hair bands.” This is a quick lesson in scarcity of money and one that they will always remember next time you ask them whether they really want to spend all their money on something versus deferring it for later. It’s going to hurt doing this, but better they learn it now than when they’re 40.

  • Teach your child a simple budget. Again, use the lesson from the lemonade stand to show how a profit/loss statement is done, since that’s what a budget is anyway. Then, have them focus on the bottom line: the profit. That’s the most important number. Again, this works best if you’ve done the lemonade stand (or any other mini-business) with your child. (Click the “Follow” button at the very bottom of this post with a note that says “send me the free lemonade stand guide” and we will email it to you. It comes with a simple p/l that you can use as a budget with your child.)

The Bottom Line

How does “The Millionaire Next Door” have the power to be so cheap? Don’t they enjoy good things? It’s because they understand how to make money by spending.

Rhett looks and sees two cars. He sees it as a $28,395 decision ($61,395 minus $33,000) and rationalizes it as “only” $771 a month. But a future millionaire knows that it’s really a $740,160 or $1,072,000 decision. Because Rhett spends so fast, his money moves too slowly.


Next Monday: I’ll take you through other spending tools for yourself and how to teach it to your children.

Next Wednesday: Our monthly giving update will start. We’ll show you how much we made and gave in August.


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