How do you decide if something is cheap or expensive? When does something become a worthwhile purchase even if the upfront cost is high? How do we compare alternatives?
In this post I look at the concept of cost per use which can help us make more informed purchases and save money over the long term.
The financial independence movement sometimes has a reputation of being all about penny pinching and only buying the cheapest of everything. However that's often not the case and it's generally better to focus on value and quality over upfront cost.
Cost per use is a way to think of purchases not in terms of their upfront costs, but rather how much they cost each time we use them. This is a great way of gaining a different perspective on potential purchases and comparing them to other options.
To calculate cost per use, you'll need to divide the cost of an item by an estimate of how many times you'll use that item. Of course, be sure it include any associated costs like insurance or maintenance if it's a bigger item you're considering (eg: a car, swimming pool, house renovation etc).
I was listening to a podcast recently where a caller was planning on buying a new house and was trying to decide between a 3 or 4 bedroom place.
The caller had two teenage kids and so getting a 3 bedroom place would allow for each kid to have their own bedroom with the main bedroom being used for him and his wife. Makes sense.
So what was the thinking behind considering a 4 bedroom house? The reasoning was that if he purchased a 4 bedroom house there would be a room available when guests stayed over.
There might be a slim argument that if guests are staying over every other weekend, a guest bedroom is worthwhile. However these stay overs evidently only happened two or three times a year which meant the 4th room would remain unused for the rest of the year. For over 350 days each year, the room would be empty and likely to be used as a storage or junk room.
It quickly became obvious that on a cost per use basis, the extra room was a complete waste. Any number of alternatives would be worth considering such as the kids sharing a room for a couple nights each year or even paying for an Airbnb for guests.
Cost per use comes in handy not only when considering whether or not to buy something, but also when deciding on alternatives:
It's worth considering things like warranties and guarantees along with cost per use. For example when buying appliances they'll often come with different terms and conditions with respect to their warranty.
At face value, one item may have a better cost per use however it may have a very limited warranty. On the other hand an item with a slightly higher cost per use with a longer or more comprehensive warranty may be the better option.
Again, do the math and include your best estimates of number of uses, insurance, repair costs and maintenance etc.
There's a couple caveats to cost per use that we should be aware of:
Well known brands often tend to sell their products at a premium. It's worth considering whether that premium relates to better quality and a longer lasting product or if it's simply a cool new thing that's being hyped up.
Fashion is one area where brand hype happens a lot. Once a trend starts in the world of clothing, it's often not about long lasting quality but rather about what's currently fashionable.
In terms of cost per use, it's generally better to spend more money on something that will last a few years rather than something that's currently trendy and fashionable but which will start falling apart in a year and need to be replaced.
The risk with leaning too heavily on cost per use is that we might start justifying purchases which we would have otherwise not considered.
I think it's important to only apply the cost per use strategy to items which we were already planning on purchasing. Without that constraint, it becomes all too easy to justify just about anything.
Black Friday (and any other sale) shouldn't be a chance to go crazy buying everything in sight just because it's so cheap. We've all seen the videos of people losing their minds in stores on Black Friday, clawing at everything in sight.
Instead, use Black Friday strategically and plan ahead. When there's something you need to buy anyway, can it wait a couple months until Black Friday? If so, research current prices and then only look for those specific items on Black Friday which you've had your eye on. All of a sudden your cost per use is supercharged.
If you get to Black Friday and the item you've had your eye on isn't on sale, no harm no foul, buy it at that point anyway knowing the cost per use.
There's a great quote from Warren Buffet who is one of the most successful investors of all time:
Price is what you pay, value is what you get
I think this is applicable to cost per use. Sometimes the cheapest item is the way to go, however sometimes it's worth paying a bit more for something that will last longer.
Crunch the numbers and pay for long lasting value.
Article by Brendon @ Money FI