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Yet I see it day after day.
People making dumb, irrational decisions when it comes to their money. Acting in ways that will never allow them to achieve some financial progress.
One of the most prominent cases is the consumerist behavior they present. Driven by their emotions and manipulated by clever advertising, they mindlessly spend their hard-earned money on items that offer them little or nothing on the long term. This is a surefire way for wealth destruction.
Going bananas over the iPhone
This post was prompted by a ridiculous phenomenon that I observe time and time again in my home country. It involves the mega-popular mobile device iPhone, created by one of the largest companies in the world, Apple.
The iPhone is extremely trendy here, with consumers going crazy about it. The device sells like hot bread and the majority of the owners always upgrade to the latest version. For one of the latest versions of the device, there was even an unreal number of pre-orders made, so that people could have it in their hands before anyone else.
Now, to give you some context, the minimum wage here hovers around $740 (before taxes). Additionally, due to the recent financial crisis, the local labor market has pretty much gone to hell, so the real number sometimes is even lower than that (since employers adopt “flexible work hours”).
The astonishing thing is that people on minimum wage (or even lower) will purchase an iPhone, blowing away one month’s salary (or more). Then, they will routinely make missed calls to the people that they want to contact, so that he calls them back, since they can’t afford to purchase a monthly plan or even a prepaid one. Insanity.
It seems that people think it is perfectly fine to spend one month’s salary for a status symbol (because that’s what iPhone is), while they can’t afford other basic stuff (like a decent mobile plan).
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Your iPhone or your Life
Perhaps you too have have fallen into this consumerist trap, buying stuff that you can’t really afford, with the sole purpose of impressing other people. It might not be an iPhone, but perhaps something else. And this begs the question…
Have you ever calculated how many hours of your life did that iPhone cost you?
What do you say? It cost you money? Well, think again.
The real currency with which you pay for stuff is neither dollars or euros. It is hours from your own life.
Think about it. Unless you are a millionaire heir, you don’t have money falling from the sky. You have to actively work in order to earn it. Most probably you have to work for a day job that you don’t even like.
Those hours allocated towards that work will be eventually translated to money. It is those hours that you “spend” in order to be able to purchase stuff.
Vicki Robin, author of the excellent personal finance book “Your money or your life”, uses a great term to describe this: “Life Energy”. She says
“Our life energy is our allotment of time here on Earth, the hours of precious life available to us.”
So, based on our previous statement, how does money enter the equation?
“Money is something we choose to trade our life energy for.”
Let that sink in for a moment.
In essence, you are trading hours of your precious life in exchange for items. This is what every purchase of yours boils down to. Are you certain that you are making the most favorable trades?
It is not always easy to make such an assessment, so we need a framework to help us with the process. This is where the calculation of our real hourly rate comes into play.
Calculating your Real Hourly Wage
After understanding that in order to obtain money you have to exchange a part of your own life, you need to find out how efficiently you are doing that and how much you actually earn per hour.
Calculating how much is your time worth can be a bit tricky, especially if you are a self-employed freelancer or a business owner. For this reason, we will keep things simple and examine the simpler case of an employee. You can adapt the concept to your own situation after you understand the rationale behind it.
For this example we meet Johanna. Johanna is fresh out of college, but she couldn’t find a job related to her field, so she settled for a job as a customer service representative. She is quite good at this, so she has already earned a couple of promotions and her wage is a bit over the average, but of course nothing special.
One day, her eyes fall on the latest iPhone and, instantly, there is only one thought in her mind: she wants it. The price tag is a bit hefty, but according to her it is definitely worth it.
Of course, she rationalizes her desire by listing all its high-tech features and technical specs, but the real reason is purely emotional. The iPhone is a status symbol; plain and simple. Johanna wants to show to the world that she is a strong and independent young woman, and the iPhone will help her demonstrate that.
Let’s break down how many hours Johanna needs to spend in order to buy one.
We suppose that Johanna earns $750 per week and that she works 40 hours per week. A naive approach would be to consider that her hourly wage is $750/40h=$18.75/h, but this is far from the real figure.
This figure is inflated due to two reasons:
- We have not calculated the overhead time related to work
- We have not taken into account expenses associated with the job
Let’s include these factors to our example, so that we have a more accurate picture.
First we need to adjust for the time related overheads. For example, Johanna is not teleported to her workplace, she needs to commute there. This can be a huge overhead especially in metropolitan areas. It is not unusual for people to waste two or more hours per work day during their commute.
Commuting is usually the largest time overhead, but it is not the only one. For example, employees face what I call “job spillovers”. That could be work you take home, or even accepting phone calls from colleagues while you are outside work. These have to be added to the analysis.
Finally, we need to account for hours spent into recovering from a job. If you are working several hours in a position or work environment you don’t like, it can take a toll on you. So you will probably need to “blow some steam off” and recuperate. Well, this time should be considered “work time” since it would not be needed if you did not have that job.
On the other front, we also need to calculate any expenses directly related to Johanna’s money earning employment. These could be anything from clothes that she has to buy in order to adhere to a specific dress code or even the meals she needs to order because she does not have enough time to prepare her food at her own home.
In general, we have to consider any expense that would not be present if you did not have a day job. For example, if you have a nanny for the kids, or a cleaning lady for the house, you should factor those in. You should go as far adding job-related illnesses which can be caused from the lack of exercise for instance.
Note: If you are a high-earner, something you eventually should be, you would obviously need a cleaning lady and other people doing your chores for you. But this does not change the fact that this cost should be added to our hourly-rate calculation.
So, let’s see some actual numbers for all the above. We will list a category of items and then analyze what the impact in work hours and expenses is.
Johanna needs to commute around 1.5h per work day. She usually uses public transportation but sometimes she drives to her workplace.
Time: 5×1.5 = 7.5h per week
Johanna spends several minutes per day getting dressed and putting on make-up. She also needs to purchase some clothing items.
Time: 1.5h per week
Johanna orders her meals while at work, so doesn’t spend any time for it, but the cost can be significant. Throw in a cappuccino here and there, and a serious amount is spent.
Time: 0h per week
Johanna routinely gets calls from work since she is the most experienced person and can help them solve any issues immediately.
Time: 1h per week
Chilling / Entertainment
Johanna rarely works overtime but her job is quite demanding and stressful so she needs a little time after work to chill. Additionally, she needs to have some entertainment in order to compensate psychologically.
Time: 5+5=10h per week
Other Job-Related Expenses
Johanna hires a cleaning lady to do her house cleaning for her.
Time: 0h per week
We could go further, but these are the main items. Let’s do some simple math now.
Hours per week: 40 + 7.5 + 1.5 + 1 + 10 = 60 (a 50% increase over the “naive” approach of 40 hours per week)
Expenses: $50 + $10 + $35 + $35 + $20 = $150
Real earnings: $750-$150=$600
These “Real earnings” are not very real. What is missing? Taxes of course.
You have to account for taxes, since this is money you will never get. Especially if you are a high-salary individual, taxes can be a large portion of your paycheck. Government has to take its share from you labor, it is how things work.
The even worse thing is that you are taxed on the whole amount of your income, and you can only use what is left for your expenses. This is the opposite of how corporations are taxed, where taxes are applied to net income, i.e. income minus the expenses.
So let’s assume a conservative 20% tax rate, which means that the after-tax weekly salary would be $750 x 0.8 = $600. With that we have:
Real earnings: $600-$150=$450
Real hourly wage: $450/60h = $7.5h
Now is this sad or what? This figure is far lower than the one in the original “quick math” approach. Also, note that this is a best case scenario, where we have not counted any possible unpaid overtime or other overheads.
Trading your life for an iPhone
So, what is going on here?
The first thing to notice is that our perception about our hourly rate is totally skewed in most cases. Unless we sit down and meticulously go over all the details, we will not be able to accurately calculate our real rate.
On a second note, as sad as this analysis might seem, it is actually good news because it helps us put some perspective on things. It helps us assess what is the impact of each of our purchases on our own lives.
Using that thought process, Johanna now has a decision to make. Assuming a retail price of $600 for the iPhone, she calculates she needs to spend 80 hours (600/7.5) of her own life in order to obtain it. Is this a favorable trade? For me personally, it wouldn’t be.
Coming back to my fellow country people, a similar analysis would show that the real hourly rate of a person with the minimum wage is around $3.
If your iPhone is going to cost you 200 hours of your life, is it a good purchase?
Of course this is not only about the iPhones, this applies to every consumer item or purchase we make. Note that some people go one step further and buy those consumer items on credit. This is so much worse and makes the “life energy” amount needed much larger.
So what is the answer here?
First, we need to control ourselves and tame our emotional impulses. We have to honestly ask ourselves, “Can I truly afford this?”. There is a quick test to determine whether you can afford an item or not:
If you can pay cash for the purchase and your lifestyle isn’t impacted, you can afford it.
If you have to allocate 200 hours of your life in order to buy a gadget, can you really afford it? Think about it.
Look, I am not advocating going after a “frugal lifestyle”. This is another path towards mediocrity. But what we have to do is take care of our “defense”, i.e. our spending habits and expenses, while we are working on our “offense”, i.e. our income potential. And as I have mentioned many times, “offense” is more important in the long run. Speaking of “offense”, here is the next step.
Second, we need to raise our income. At the end of the day, it all comes down to this. Achieving a high income allows us to be more flexible and truly afford more items (perhaps some luxuries too).
Suppose you had built an online business unit that provided you with cashflow in a semi-automated way that boosts your real hourly rate to $200. In that case, you would need to trade only 3 hours of your life energy for the device. That is obviously a much more favorable trade.
The most important takeaway of all these is that, deep down, all our purchases are funded by our “life energy”. We spend a great portion of our lives in the money making front and these hours are the true currency we buy stuff with.
By following the simple framework and line of thinking presented here, you will be able to calculate your real hourly rate, after all expenses and overheads are taken under account.
This figure should then drive your financial decisions. You should be able to properly assess whether a specific purchase is worth it or not.
If you find that your real hourly rate is low, then you should take measures to increase it. This will not happen overnight, but with a solid plan, you can gradually increase it and after a few years, make it explode.
And as a final note, just keep this in your mind:
The higher you value one hour of your life, the larger your success will be in the long run.