Friday, February 13, 2015

Can You Afford It?

A lot of us make more than enough money to take care of life's essentials. It's when we consider other possible purchases that we tend to screw up. We don't seem to know what we can afford and what we can't. That is when we turn to credit to fund our extravagances, and we get into trouble.

Have you ever noticed that most books on personal finance do not discuss what we can and can't afford? Most personal finance TV segments don't discuss limits on spending, either. Suze Orman is the rare exception, with her "Can I Afford It?" segment on her television show. But even Suze has only lately come up with a formula to help children--not adults, but children--determine how much of their savings to spend on something they're lusting after. Suze says spend no more than 10% of savings on any item you want but don't need. It's a great concept, but hard to put into practice as an adult because we'd have to look at it in reverse to determine where to draw the line.

During the Cold War, a very long time ago, magazines sometimes ran cute little features comparing how many hours a U.S. citizen had to work in order to afford to buy a suit or a dress, versus how many more hours a Soviet Union (Russian) citizen had to work. Of course the U.S. always came out better in these comparisons, because we had and still have superior access to a wide range of consumer goods, many of them at cheap prices. People in the U.S. were paid well back then, too. The situation has changed. We now are paid badly compared to the inflation since the Cold War, but the price of clothing has dramatically reduced, to the point where people feel they can buy items and never wear them, or wear them only once, and then ignore them. Determining what is too much in this scenario is complicated because you'd have to add up every dime you spent on clothing and then compare it to your income. Few people do that.

Let's consider something simple, a Coach bag. Coach makes leather handbags, purses, and other accessories. These are good quality items in solid leather that usually will wear well for decades. Thus a Coach bag, which can easily run $300, can be viewed as an "investment" whose cost will amortize over the long time it can be used. If you're the kind of person who is willing to carry the same bag for decades, buying one that costs 6 times your usual $50-on-sale bag might make a kind of daft sense. Except that most people who become fixated on a designer handbag don't use it exclusively, or that long, because they will be captivated by some newer design or designer. An Hermes Birkin bag can run you $10,000. That's 33 times what the Coach bag costs. If you bought a house that was 33 times the price of a house you could afford, and your bank approved you to buy a $500,000 house, you'd be spending $16.5 million dollars on a house. That's how out of whack buying a Birkin bag is for anyone who is not rich. But what about the Coach bag? How do you discover whether you can afford it, or whether you ought to buy a less expensive brand at a discount store or on sale somewhere?

First you look for descriptions that suggest what percentage of income can or should be spent on clothing. A shopping site that seems to push expensive clothing says 5% of your net pay, your take-home pay, is the limit. Let's assume for giggles that you only bought one clothing item, that Birkin bag, all year. Your net pay after taxes would have to be $200,000 a year. Yikes. What about the Coach bag at only $300? There it begins to get complicated again. Three hundred dollars is 5% of a $6,000 a year income, but $6,000 a year is below the poverty level. The 5% figure doesn't help us here because it's not a reasonable purchase with such a low income.

A personal blog that isn't trying to flog expensive clothing cites the Bureau of Labor Statistics information that the average family spent $1,700 on clothes in 2010, on after-tax income of $60k. That's 2.8%. Assuming there are four people in the family, that's only $425 a year per person. On the face of it, then, a $60k take-home income does not justify spending nearly 71% of your annual personal clothing budget on one Coach handbag. What happens if you go ahead and do it, and then you need new running shoes, a couple of t-shirts, and a pair of sweatpants? Even buying them all at discount stores, you'll be over budget in the wink of an eye. If there are only two people in the family, each person has $850 to spend all year, and the Coach bag represents 35% of it. Still too expensive.

Typically, women are pressured by our society to spend more on clothing than men do, which often pushes the percentage higher. On a $60k net income, that's $3,000 a year, and the Coach bag is 10%. We're back to Suze Orman's standard number.

It's so tempting. That Coach bag would look good on the custom-built shelf in our walk-in closet--except that with a take-home pay of $60k, we don't have a walk-in closet or a custom-built shelf for designer handbags. Too many of us want to pretend we can afford the appurtenances of the wealthy, when we can't.