Where to Start When Making a Big Purchase

If you have not experienced the dreaded moment when you realize that you are going to have to make a big purchase because of a computer, car or a home appliance breaking down then trust me – it is only a matter of time because it is just part of life. Things break and sometimes you just need a pricey item that you did not previously own. The goal of this blog is to help coach you through how to handle these situations in the most financially feasible way possible.

1) If it is broke, can it be fixed? 

Often times when an old car breaks down or the computer fails the first assumption tends to be we need to go buy a new one. While that may end up being the case it is not always and many times the best option is truly to get the broken item fixed -especially if money is tight. Take for example when your car breaks down. It can be so frustrating! Especially when the mechanic comes back with a price to fix it exceeding $1,000. Our mind immediately goes to the reasoning that people around us have used in the past when facing the same situation. You hear them in your head saying, “The car is old already, it is not worth a whole lot, why would I put $1000 into it when I could go buy something much newer?” Then they end up purchasing a car and either spend way more cash than the $1000 on repairs or take a loan out to purchase the car that ends up costing them more $1000 in the first 4 or 5 months of paying back the loan. Making a new purchase just because what we have is old and in need of repair is not always the best option as I have hopefully convincingly presented to you, the reader.

Consider if you did just pay the $1000 to fix your car and it gave you another 3 or 4 quality years of life. In my book, that would be worth it especially if that kept me from having to finance a new car before I was ready to make that purchase. If you do just fix the car it also gives you the time to plan financially and save for the purchase instead of making a big financial move on the whim when you were not planning to do so. Not to mention it would save you a ton of money of the 3 or 4 remaining years of the car’s life. This same principle could be used with home appliances, computers and etc.

I recognize that sometimes there just is no shot at saving the big item and you will have to make a big purchase. The rest of this blog post focuses on the steps to take to make financially feasible and responsible purchases of big items.

2) You’ve determined that you are going to buy. Where to start? 

When you hear someone say you should start your search for the big item by determining the monthly payment amount you can make on a loan for the big purchase item or how much cash you are willing to drop on the item you response might be “duh, that is obvious”. Well, yes and no. I would argue that while it might be common information it is not always practiced.  Even when it is someone’s first step in making a purchase a good sales person looking to earn some commission can give a pretty convincing argument for why you should spend just a little bit more and before you know it you’ve made a purchase costing you way more than you initially planned.

If you are financing the purchase it is important to take a good look at your written budget and determine how much you can afford to pay each month. Make sure that the amount you determine does not stretch you so thin that it is possible certain months you will miss payments. If you do not have a written budget do not trust your mental math to make a financing decision. Write it out to make the decision – there is a good chance that if you don’t take time to write out your budget you will be sorry later. If you decide to pay in cash be sure to not completely exhaust your savings to the point where there is not any money in your emergency fund.

If you go the financing route once you have determined how much you can afford to pay monthly you are now ready to determine the maximum dollar amount the item can be that you plan to purchase. Make sure to consider tax and loan interest in this calculation especially if that purchase happens to be a car or a home. Also consider and determine if it is going to cause any other expenses to increase such as insurance, utilities, property tax or gas to name a few. Once you have finally determined the maximum amount the item can cost you are ready to start shopping!

3) Start with Research!

Do your own research. This is the only way that you can make sure that you have all the information you need to make the right purchase for the right price. If you have done your research it will save you a ton of time once you arrive at the car lot, the appliance store, or wherever you are making a purchase. Secondly, you will not have to rely on the knowledge of a sales person. Finally knowing your facts will help you know if the deal being offered to you is worth your money, if you need to go somewhere else to make your purchase, or if there is room to negotiate the price of the item down.

4) Do not settle. 

If your research conclusively shows that you can get a better deal then do not settle and pay more for the item than what it is worth! Do not feel guilty for not buying an overpriced item because the company offered great customer service. You still have to do what is best for you financially and you have a dollar amount that you have to stick to! It is not personal, it is just business and the kind customer service folks will understand that – though you don’t even have to justify why you are not buying from them.

Making these kinds of financial decisions can be super tough. Here at the Center for Financial Success we are here to come alongside you during the decision-making process. If you would like to speak with one of our financial counselors visit our website, wku.edu/cfs and fill out our become a client form!

Understanding Present Value and How to Solve for it.

In this post we simplify present value time value of money calculations. This is a continuation of our blog posts on understanding the time value of money. If time value of money is a new term for you then check out our first post in this series on the time value of money. In that post we cover the basics of time value of money.

What is the value in today’s dollar of an amount of money that will be received in the future? This is what present value calculations find.

When solving for present value we use the term discount rate instead of annual interest rate because we are discounting a future sum of money back to its present value.

The easiest way to calculate present value is with the time value function on a financial calculator. If you are trying to determine what the present value of $1,000,000 is that you will receive in 10 years at a 10% discount rate then you would enter the following inputs into your calculator.

FV=1,000,000

I/Y=10

N or Periods = 10

PV=?

Click CPT PV and you should get = -385,543.29. (this answer is rounded to two decimal points)

*Note getting a negative on either PV or FV is normal. Typically if you are solving a Time Value of Money question that includes both PV and FV you have to make one of them negative for it calculate properly. The reason it is like this is because it is showing money leaving your hand as the negative and returning as the positive.

The greater the discount rate is will equal a smaller present value given that everything else is the same between two future value sums of money. For example if the same numbers are used from above, but the discount rate is 4% instead then the present value will be larger.

FV=1,000,000

I/Y=4

N or Periods = 10

PV=?

CPT PV = -675,564.17

If you are wondering how time value of money is affecting your life then consider this- from a practical standpoint understanding time value of money is important in making every basic savings, credit and investing decision. It is key knowing how to create and maintain wealth.

Basics of Time Value of Money

Money has a time value

The money you have today is worth more than what you have in a year. For example if you were to have $1500 now it is worth more than $1500 a year from now because of compound interest. This is dependent on if you taking advantage of compound interest. You have the opportunity to earn interest on money that you have now.

Compound interest is interest that you earn on interest you’ve already earned. For example if you invest a principal (starting amount) of $100 and you earn 7% in a year on the $100 investment then you’ve earned $7. If you choose to reinvest that $7 of interest then you now have $107 earning interest for year two. This may not seem like a whole lot, because it is a simplified example. However, consider once you have saved up money and have invested for a few years. Consider if you now have $100,000 dollars earning 7%. That means in one year you earned $7,000. Once you reach $1,000,000 if you are earning 7% that means you are earning $70,000 and that the next year you now get to earn 7% on $1,070,000! Compound interest can be your best friend if taken advantage of, the earlier you start using it in life the better!

Compound interest is much like a ball rolling down a hill. Untouched, the further it is allowed to roll the faster and more momentum the ball picks up. Compound interest is the same way! When you add more money to the principal it speeds up the process even more. It is kind of like kicking the ball to speed it up even more once it already has momentum.

Definitions for Time Value Calculations

Present Value is what money is worth now. For example if I have $150 right now that is its present value.

Annual Interest Rate – if you have an account that pays 5% a year then that is your annual interest rate. If the $150 that you have earns 5%, then at the end of year 1 you will have earned $7.50.

Future Value is what the money will be worth at the end of year 1 or at another point in the future. In the example of $150 at an annual interest rate of 5% the future value after one year will be $157.50.

When calculating Future Value or Present Value you will also need to know the term or in other words how many times does the interest compound and is it once a year, semi-annually, quarterly, monthly in the time frame that you are calculating. The easiest way to compute a time value equation is to use a time value calculator.

Non-annual compound interest

Non-annual compound interest is when interest compounds on a term that is quicker than a year. It could be semiannually, quarterly, monthly, and even daily. The quicker your money compounds the quicker you earn money on your interest.

To compute non-annual time value equations it is easiest to use a financial calculator’s time value functions.

Understanding time value inputs on a calculator

The pictures above display what the inputs will most likely look like on the BA II Plus Texas Instruments financial calculator and on an internet time value calculator. There is also many financial calculator apps available for smart phones. Usually they are no more than a few dollars.

PV or Present Value – is where you input the present value or where the calculation will occur for Present Value

FV or Future Value – is where you input the future value or where the calculation will occur for the future value

The N or Periods – is where you input the number of payments or compounding periods or where the calculation will occur for the periods

PMT or Payment – is where you input how much money is being contributed per period (if money is being contributed) or where the calculation will occur for how much to contribute.

I/Y or Rate/Annual Rate – is where you input what the interest is per term or compute what the interest rate is per term. It is entered as a percentage not a decimal. For example if your annual interest rate is 12%, but it is compounded monthly you would input 1.

If using the BA II Plus Texas Instrument calculator click the “CPT” button and then which ever input you are wanting to find. For example if you are wanting to find present value, once you have inputted the numbers into FV, I/Y, N, and PMT click “CPT” and then click “PV”.

Summary

This blog post is intended give the reader the baseline knowledge of time value of money and compound interest needed to then delve deeper into the topic. The topic of time value of money expands well beyond the scope of this article. We will be adding additional posts on the topic of time value of money in the near future.

Vision for Financial Success

If you are like me (I would wager most are) then you have dreams of things you would like to do or accomplish in the future that require money. I would imagine that many of those bucket list items require more than just a few dollars saved up to accomplish. I find that often we leave these bucket list items stagnant. They can end up being more like daydreams than realizable goals. I would like to suggest as long as these items are more like daydreams then realizable outcomes they probably will not happen.

Having a vision (clear direction of where you want to go) with your finances will be the first step in creating a means to turn those daydreams into something that could happen. Once you have a vision for your finances than you can begin to establish a financial structure to make it come to pass. Profitable companies always have a strong vision and mission statement. It works for an individual or family as well. Once a company establishes a vision they are able to create a mission and objectives that work towards attaining the vision. The same can be said for an individual with financial vision. While it doesn’t have to be as structured as a company, with a vision in mind the individual can begin to create objectives they want to meet that gives a structure and lens with which they can make financial decisions.

When establishing a vision for your financial success ultimately it should be what makes you happy. Comparison to other individual’s finances is a trap. It can lead you to try to keep up with the Jones’ instead pursuing objectives that fancy what will make you happy.

In terms of practicality – establishing a vision for your finances most likely will mean establishing where you would like to be financially 1 year from now, 5 years from now, 10 years from now, and so on – all the way up into retirement. This can include how much you would like to have saved/invested during this time frame, big purchases that you would like to make, how much debt you want to pay down, where you want to be living, what would you like the size of your family be, etc. The further out you go it probably will not be as precise as where you want to be one year from now and that is okay!

It is normal to change these items as you grow and move along in life. Some of the items on your list can be items that have factors that are outside of your control such as the example I used above of determining what size you would like your family to be at any point in time. Items like this should be listed so that you can determine more controllable objectives such as home purchases, and the standard of living you will want to have reached through a combination of income level, expense control and savings. This makes it possible for you to be where you want to be financially in the event that the less controllable things occur like the desired size of your family.

Now, let’s talk practically how to achieve the vision you have laid out! For each item you have listed as part of your vision, take time write out the practical objectives/goals you will need to accomplish to reach each item you have listed. There will be certain goals that apply to each statement and can just be written as key general goals to obtain financial success. For example – breaking the cycle of living paycheck to paycheck will be key reaching any item that you have written down. Having an emergency fund equaling 3 to 6 month’s salary is another key objective to meet that will be key to reaching other objectives written down. When you are working through building you goals/objectives check out this article that I wrote on goal-setting.

Giving your money vision will change how you view every transaction you make. In a way you are giving purpose to your financial decisions -spending and saving because they are now working towards your vision. It doesn’t mean you have to refrain from spending money or that you never get to have fun anymore it just means that you have become wiser when you do spend and don’t have to deal with near as much buyer’s remorse later. Rather you can give yourself the freedom to spend money within your plan knowing it will not keep you from attaining all that you are planning to accomplish. Finally, it means you are now on a track to reach your version of financial success.

 

4 Benefits to Having a Financial Plan

Money can be a taboo topic, yet, we all think about the need to have a plan for our money. Few seem to make it happen. In a recent 2018 study by an investment company, Charles Schwab, it was discovered that 3 in 5 people are living paycheck and only 1 and 4 people have a written financial plan. I would suggest it is not surprising to discover that more than 50% of people are living paycheck to paycheck when only 25% have a plan. Having a financial plan is an absolute game changer. Here are 4 benefits.

1) Maximize the use of your income and accumulate wealth.

When you have a good plan you able make your income go farther, increase your wealth and over time make your money work for you. This happens through breaking the paycheck to paycheck cycle and paying yourself through savings and investing.

2) Control your expenses.

When you have a good plan it gives you a lens which through you can make prudent spending and saving decisions. Some might say it means that it removes the opportunity for fun. I would argue just the opposite. I would argue that controlling you expenses enables fun without financial disaster, buyer’s remorse later, and anxiety that comes from a low bank account.

Living below your means by controlling your expenses will produce a much greater financial reward in the years come.

3) Reach Your Version of Financial Success.

Having a plan will be the only way you reach financial success. Each and every individual’s version of Financial Success is going to be different. However, it is important to know what you envision financial success looking like for you and then make it happen! Make sure it is your vision and no one else. If it is not yours, it will not make you happy.

4) For those that desire: the empowerment to give back. 

It can be hard to give back financially to your community, preferred charitable non-profit organization, or religious entity of choice without a plan that is keeping you thriving financially. Many people want to give back, but do not have the means to do so. Planning now will enable you to give back now and give back even more later!

If you you would like help building a plan that helps you reach financial success visit our website at wku.edu/cfs and fill out our become a client form! We look forward to coming alongside you in your journey to financial success!