Picture it -- you're standing in front of a jewelry counter, gazing at a $6,000 diamond necklace. You're thinking of buying it for yourself or your loved one. You're reasoning with yourself: "I'm not irresponsible. I've saved and invested a few thousand dollars already this year, for retirement. I can afford this. It won't go on my credit card, costing me gobs of money in interest."
Add a zero?
That may sound good, but look at it this way: According to a rule of thumb I ran across in Money magazine recently, you should add a zero to a price tag in order to get an idea of how much you're giving up in retirement money. (The rule assumes that the sum would be invested for 30 years, earning an annual average of 8%.) So that $6,000 necklace is suddenly a $60,000 withdrawal from your retirement nest egg. Does it still seem worth it?
According to our Rule Your Retirement newsletter (which you can try for free), in order to make your nest egg last, you should conservatively plan to withdraw about 4% of it per year in retirement to live on. Four percent of $60,000 is $2,400, or $200 per month. So that necklace may be costing you some $200 per month in retirement. Still worth it?
Imagine that you're deliberating between buying a $25,000 car and a $45,000 one. The difference is a $20,000 hit to your net worth. Tack on a zero, and you're looking at a $200,000 shortfall in your retirement savings -- which can mean a loss of $8,000 annually, or $667 per month.
And another thing ...
Some might say that the rule of thumb is calculated rather conservatively. If you expect to earn an annual average of 10%, not 8%, over 30 years, the multiplication factor zooms from 10 to 17! A $6,000 necklace translates to a $100,000 opportunity cost. A $20,000 car price difference becomes $340,000.
It's not crazy to be aiming for 10% average annual returns, either. A bunch of stocks and mutual funds have met or topped that mark over long periods. Nordstrom
So next time you're mulling a purchase, stop and do a little mental math.
Longtime Fool contributor Selena Maranjian owns shares of Yum! Brands. Activision is a Motley Fool Stock Advisor recommendation. Try our investing services free for 30 days. The Motley Fool is Fools writing for Fools.