The other day I was thinking about my spendings. Once in a while I get puzzled when I look into by bank account. When I introspect, almost always I feel like I have been victim of some online security intrusion and my money has been transferred into some hackers account.
But when I look more carefully, though, I realize that its not the case. All my money was and is still there with me. But somehow my spending has been more than what I thought.
Also I am kind of thrifty(my friends might say that this is good use of euphemism). But its true that I and many of us are not able to judge if any perticuler good or commodity is worth its values or not. When buying something, there are many criterias that one can apply. Quality and brand name are some of the very important ones. However, in some cases, its difficult to choose the way as all options have similar weight. Also there are cases when you can't really comment whether its ok to spend given amount of money for something.
I was thinking about this and it was difficult to objectively judge spending decisions. Then I came up with this very simple spending model which can explain if something is worth spending the money on. This helped me a lot to determine few over spendings and in some cases justify/oppose certain spending decisions.
This simple model goes like this -
spending worthiness index(index) = (your monthly salary/100[gc]*expected utility duration[ud] of the product in months)*(importance multiplier[im])/product value
gc - goods count(no of things you wish to buy in a month time), standard value is 100
sf - salary fraction = your monthly salary/gc
ud - utility duration in months(time for which good will last/good would be retired, whichever is earlier)
im - importance multiplier(how much the good is important, alternate way to calculate is - 100/no of such goods you need in your lifetime(applicable for non moveable assets mainly))
if product value < (your monthly salary/100*expected utility duration of the product in months)*(importance multiplier)
For normal people with normal salary/income, this 100 coefficient is good enough. You can alter it to some extent according to your position.
Importance multiplier is usually a whole number and equal to 1 for all normal scenarios. You can decide this number yourself, but general observation is for certain luxury goods, this is higher.
Now if product value is more(or index is lesser than 1), then obviously you are over spending. If its less(or index is higer than 1) then that prodct is worth. Now, it should be noted that for certain product catagories this importance multiplier is not equal to one. In such cases all other products in the same catagory should be evaluated with that multiplier and conclusion should be reached.
Now some real world example,
Lets say I have monthly salary of 25000, and I have bought Nokia 5800 for 18000rs 3yrs back. Now, I am thinking about buying a new phone. When should I buy a new phone?
According to spending model that was mentioned, I have used the phone for 12*3=36 months. 250rs is monthly allocation. Which means, in 3 yrs I have used 36*250=9000rs out of initial spending of 18000. This means that after 3 more years I should start thinking about new phone.
How about a watch? How much you should spend on it? Usually we use watch for more than 5yrs. 12*5=60months. Considering 25k/pm salary, it comes to 250[sf]*60[ud]=15000. Which means you can easily go for swatch/rado watch! Its really worth. it!
For your own house -
You would use it for 30yrs, which means 30*12=360months. 360(ud)*250(sf)=90000. Now this is completely wrong. For such assets, importance coefficient of 10 or more could be applied.
For a car,
utility duration = 10yrs = 120[ud]*250[sf]*10[im]=300000rs.
There is another perspective to the importance coefficient. This should be chosen as -
importance multiplier=100/number of similar things that you wish to have
For example, you might want to own 3 houses. Which means im of 100/3=33 should be applied. If you recalculate again then this is now this is closer to what we usually spend to own a house in bigger cities like Pune.
Similarly for car, if you start at the age of 25, you might own 4 cars in you life time. 100/4=25. If you apply im of 25 then you can spend 120[ud]*250[sf]*25[im]=7.5lakh for car.
How about some commodities? Is pizza worth? Is pavbhaji worth?
pizza : utility duration - 1/30month but probably you eat pizza once in a week, so its 7/30. now 7/30*250=53rs. But pizza is much more costly than 53rs. Which means we are definitely over spending! This also means that you should eat pizza once in 5 months to make it worth. However, pavbhaji is a worthy spending as it costs closer to 53rs and hence you can eat pavbhaji once a week :)
If you calculate most of the good's cost you will realize that this model fits well in most of the scenarios. But there are some definite outliers.
Now some reasoning behind this model -
gc of 100 is chosen because with this value, meaning is, you can buy 100 such things in a month. If you count all things that you buy in a month(even commodities like bread, biscuit, subji, wheat, rice, CDs etc) 100 is a good and large enough number.
Utility duration is important as the amount of time perticular thing lasts varies. Short utility value things cannot be costly as one cannot afford it
Similarly, there is importance attached to some things like car, house or your hobbies, so in such cases higher coefficient could be applied.
Its kind of tricky to find out utility duration and importance multiplier, but in most cases you can find some aggreeable and correct number or you can deduce that number from other thing in that catagory(like pizza vs pavbhaji comparison). Also you can apply usual notions of something being more useful or more costly to alter [im], but 1 is a good default. Like non veg food is more costly than veg food is acceptable and hence non veg food has higher [im]. Or education might be costly, but its very important so its ok to use unusually high importance multiplier for it.
So try using this simple but useful model which can explain your spending decisions to some extent at least. This should give you a good baseline...
