Investing Versus A Purchase: The Age Old DebateSubmitted by Castlebar Asset Management on July 23rd, 2015
My wife and I were shopping a few weeks ago when she used a line that pretty much everyone has used at least once in their life, “We need to invest in a new…” You fill in the blank on the purchase but every one of us has tried to justify a purchase as an investment. We all know in reality that we are just buying something. Here is a framework to figure out if you are making an investment, a smart purchase or a discretionary purchase.
To get started let me define what an investment is and distinguish between smart and discretionary purchases. An investment is when you acquire something that will provide you a return on your capital, more wealth or is good for society. We are not talking about contributions to retirement accounts, brokerage accounts or an increase to your savings. This is different than a financial asset and more like buying a real asset. Buying a business, investing in a rental house or acquiring a piece of art that could appreciate would all fall under this category. You are buying this asset with the expectation that you’ll get a return on it over time.
Smart or favorable purchases, while not an investment have a clear value added benefit to your life. This might be replacing an old unreliable car with a newer car. The value here is your maintenance on your old car may have exceeded its value and by replacing it your maintenance expenses have dropped. Your quality of life is improved because you are not dealing with car issues. This does not offer you a return on your investment but it does have a meaningful impact on your life.
Another example might be taking a beach vacation. When you return from vacation you are refreshed and a better spouse, parent or employee. Unplugging from work has reduced your risk of burn out by relaxing and recharging your batteries. This is positive as long as you did not go outside your family budget for vacation. A client recently talked to me about upgrading their air conditioner. They had the room in their budget and they would save a significant amount on their electric bill. This was not an investment but it was a smart purchase. They did not get any significant return on this purchase but they will save some money on their electric bill, their house is more attractive to a potential buyer if they sold in the next few years and this eliminates a future headache when their old unit would eventually breakdown.
A discretionary purchase is one that falls into a category of something that you don’t really need but want. This is virtually every technology purchase I have ever made. I am sure when the new iPhone is released this fall, I will want it. I’ll try to justify it to myself that it will offer me some kind of return on my time but I know it won’t. These purchases are called discretionary for a reason. It makes sense to build wiggle room in your budget for items you splurge on every now and again. If you allocate some extra money for items like this in your financial life it’s completely fine. You should not dig into your rainy day or emergency fund to pay your fun purchases.
I hope this will help you the next time you are making a bigger purchase. In the meantime, Honey, I think I need to invest in an Apple Watch.
Andrew Comstock, CFA
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.