As part of my return to frugality, I want to achieve financial independence by age 30. I want to make sure that I have financial independence for the rest of my life. I will show you how to calculate the true cost of anything using a few different calculations.
These methods can be used to evaluate buying anything from a cup of coffee to a home. Regardless of the size of the purchase, the same principles should be applied. The calculations saved me tens of thousands of dollars. I’m thankful for the time and effort I put into making sure my finances are in order.
I will show you why eating a burrito for lunch every day could be a wise financial decision. It’s a great way to make sure you have healthy, convenient meals.
I used to work with a guy who ate Chipotle every day for 5 years. He said he would eat it every day for the rest of his life. Crazy right? He might have calculated the true cost and saved the money.
Example: The True Cost of A Cup of Coffee
How much does a cup of coffee cost? The total cost of a cup of coffee is $3.24. You would be right if you answered $3. The answer to this question is more complex than a simple number. Yes, $3 is what the cup of coffee is being sold for, but it’s not the true cost of the coffee.
To determine the true cost of the coffee to you, you need to perform a few simple calculations. If you take into account the cost of the coffee, taxes and any additional fees, you can calculate the total amount you paid. Here’s what I try to figure out when evaluating any purchase:
How much money do you need to make before taxes to buy a cup of coffee? To determine how much money you need to make before taxes to buy a cup of coffee, you must calculate your net income after taxes are taken out.
How much of your life will you give up for that cup of coffee?
How much would it cost to make your own coffee? The cost of convenience can be higher than simply making the coffee yourself.
Annual Cost : If you buy coffee every day, how much does it cost? If you buy coffee every day, it will add up quickly.
If you spent $3 on coffee, how much would it be worth in 30 years? The future value of money is the amount of money you will have in 30 years. How much money would you spend on coffee in the future? You could potentially increase the value of your money if you invested it into stocks or bonds.
Before Tax Income Price
How much money do you need to make to buy a cup of coffee? When determining how much money you need to make, you need to factor in the taxes you will have to pay on a cup of coffee. You had to earn more than $3 to buy a cup of coffee because you are paying for it with tax dollars. Before taxes, the amount of money you had to earn to purchase that cup of coffee was more than $3.
Depending on the federal tax brackets you are in, as well as how much you pay in social security, and state income tax, you had to earn more money than the $3 so your true cost is higher. Depending on your situation, the amount of extra taxes you pay can vary a lot.
I first learned about this idea from one of the best money books for millennials, Andrew Tobias’ The Only Investment Guide You’ll Ever Need
If you want to calculate how much you had to earn to buy anything, you can use this formula.
A = advertised price ($3)
B = tax percentage (25% displayed as 0.25)
C = the true cost you are paying
C = A/(1-B)
The true cost of the $3 is calculated at a 25% tax rate. The true cost of the item is $3.75 at the end of the day. C = $3/(1-0.25) = $4
TRUE COST (at 25% tax bracket) = $4
Your Life/Time Price
How much of your time is spent on coffee? Is there enough value in that $3 cup of coffee? This is one of the core concepts I first read about in another awesome book Your Money or Your Life
In simple terms, thinking about this had a profound impact on my life, as I began to evaluate each purchase based on how much of my life it would cost.
This was huge for me. I was very proud of myself for achieving this goal. When I realized I had worked 3 hours to buy that meal, I stopped buying frivolous take-out.
The cup of coffee is a pretty small example and this calculation tends to be more psychologically meaningful for larger purchases, but it works for the coffee as well. The purchase of a cup of coffee can help you decide if you should spend more money on bigger items. The $4 cost of coffee is what the coffee cost you in your income. We can see how much of a difference the cost of coffee makes to our budget. If you make $16/hour before taxes, then take the true cost of the coffee. If the coffee costs $3 and it takes you 15 minutes to buy it, then the true cost is $5.
A = true cost ($4)
B = hourly rate ($16)
C = number of hours of your life
A/B = C
The hourly rate is.25 hour, or 15 minutes. If you work one hour, you will make $4.
LIFE PRICE : 15 minutes
Price of Convenience
How much would it cost to make your own coffee? Since convenience is what we end up paying a really high cost for when we purchase many items, this is a fun one. The good news is that there are ways to get the same convenience without sacrificing quality or breaking the bank.
The price of coffee is insane, as is the price of delivery food. I think the only way to get a good deal is to make my own coffee and food at home. It’s possible to pay 500%+ for a cup of coffee or food if you make it yourself. The cost of coffee at home is around $12/pound or $0.75 an ounce.
Using a It would take 0.75 ounces of beans to make a cup of coffee.
To brew a cup of coffee at home, I would have to pay 75 cents per oz of beans.
The convenience for me cost more than 400%. That is a huge expense for a small convenience. I hope the coffee example helps calculate the convenience price of an item that you can make yourself. It’s important to remember that the convenience price you pay isn’t just limited to buying items, but can also be applied to time saved by not having to make something yourself.
You can do these calculations for food preparation pretty easily too using a similar formula including costs of ingredients, BUT don’t forget to include the time you spent shopping for the item or the premium you paid for using a delivery service like Instacart.
I encourage you to calculate your own convenience cost. You may be surprised by the amount of money you can save. I was a huge Starbucks fan and grabbed a cup on my way to the office for a few years – What is $3 right? Why not treat yourself to something special with a small amount of money? I stopped by coffee to make it home before I left the house.
CONVENIENCE PRICE : A 435.71% markup
Annual Cost + Annual Life Price
Gym membership fees, daily coffees, and subscriptions are some of the recurring expenses that can be analyzed with this easy one. You can easily adjust your recurring expenses to fit within your budget by taking a look at them. The annual cost adds up.
In This Article
The Future Value of Money
Not least, Alright last. Let’s make this a memory. You are my true personal finance if you made it this far. You have taken the first step towards becoming financially savvy.
Every dollar I spend could be invested, so I always try to analyze what the future value of my money could be. To make the most informed decision possible, I consider the cost of not investing as well.
The coffee example shows the future value of money. The purchasing power of this money will be affected by inflation over time. I like to use a future value calculator to figure out what I will spend in 5, 10, and 30 years if I invested the money instead. Future value calculator is a great tool to help me make the most of my money and plan for a secure financial future.
I have built my investing portfolio by simply doing these calculations and deciding to invest the money instead.
Let’s look at some future value calculations
1. A simple future value calculation (at 6% annual growth rate) of our $3 cup of coffee reveals the following: $3 cup of coffee (5 years: $4.01, 10 years: $5.37, 30 years: $17.23)
2. Now those numbers aren’t anything special, but let’s look at the annual cost of a daily $3 coffee ($1,095) over the same time periods: $1,095 annual coffee spend (5 years: $1,465, 10 years: $1,960, 30 years: $6,289)
3. Over the same period, we can see that the $1,095 invested annually has a 6% annual growth rate. Over the 25 year period, this investment could grow to almost $30,000. I am not suggesting that you stop drinking coffee, but that you stop spending money on coffee. There’s no need to worry if you’re a coffee lover.
5 Years – $1,095 contributed annually at 6% = $8,008
10 Years – $1,095 contributed annually at 6% = $17,259
30 Years – $1,095 contributed annually at 6% = $98,051 WHAT!?!?!
I hope this helps you figure out the true cost of something before you buy it. Before committing to a purchase, it’s important to understand the total cost of the item. Let me know if there are any ways to calculate the true cost. I would like to hear your thoughts on how to factor in all the variables when calculating the true cost.
