Affording little luxuries

Black Friday was just a few days ago. My wife and daughter went shopping. My daughter wanted some jeans and other clothes, and she needed some pants for her upcoming Christmas concert at school. They are good with their money and came home with what they wanted, but no more.

My wife was recounting their experience and said that she enjoyed seeing the nice clothes. “Wouldn’t it be nice to be able to buy some nice clothes? How can we get money to do that?”

The second is a great question. Whether you’re thinking of clothes, tools, cars or any other item, the first question to ask is “how can we get money for that?”

In my world, Robert Kiyosaki is famous for encouraging people to ask, “How I can afford X?”, rather than simply believing that they can’t ever afford that item. My wife and I subscribe to his mindset in this area.

So, while driving in the car the next day, we started talking about it again. As you know from previous articles here and here, we have a rental property. The income produced by that is being reinvested to buy future properties, so we don’t want to take from that.

We also own a business, Stella’s Laundry and Car Wash. So far, 6 months in, it is cash flowing nicely. The money from that has been earmarked as the kids’ college fund, so that shouldn’t be touched either.

“So what asset should we buy that will get me money to buy some nice clothes each year?”

That is the best question. Per Robert K’s rules, when you want to buy some luxury item, or something else that is not in the regular budget, you should first buy some asset that will pay you money. That extra money is what will be used to pay for the items that you want.

Say someone has $20,000 saved up. Instead of spending a few hundred dollars of it here or there, buy an asset that pays regularly and doesn’t touch the principal.  The top two ways to do that for me would be to either buy a rental property or to invest in an index fund.

For a rental property, a single family house in our area can be had for $90,000. That allows for a 20% down payment of $18,000 and $2000 for closing costs. Assuming that a renter would be found quickly and that no expensive improvements would need to be made, it would cash flow nicely. $100 cash flow per door is the target advocated by the Bigger Pockets community*. In an optimal year, this investment would net $1200 in cash. Assume that 25% of that will be eaten by the tax man and you have $900 to spend.

To put $20,000 in index funds would mean that the equivalent cash flow are the dividends paid out by the fund. At today’s price, $20,000 would buy 484 shares of SWPPX. Last year the dividend per share was around 0.71. At the same rate, 484 shares would net $338. Assuming that these are qualifying dividends, the same 25% tax bracket individual would pay 15% on the dividend income. This would leave $287.

Now you might be thinking “this is a no brainer moron, buy the house”. You may be right, but there are additional factors to consider. There is the time factor. My time, or more accurately, my wife’s time. You see, it will probably take at least 3 months to analyze deals, walk the properties, and put in an offer. Then there are the due diligence steps. Home inspectors, pest inspectors, etc. One has to ready the property, list the property, show the property, then install the tenant. After that, it’s more or less passive income. There may be the odd call now and then, but as long as the tenant stays, then you have some nice passive income. The tenant pays down the mortgage, thereby increasing your equity.

With the index funds, everything can be done from your couch. Open an account, transfer money, buy the funds. Finito! The businesses that make up the S&P 500 will operate. Some will do well, others will not. More or less, over time, the funds will go up in value per share, increasing equity. One might want to not pull out all of the dividend so that you increase the number of shares you own.

So time must be factored in as well. The difference between the two options is roughly $613. At $25/hr, that represents 24.25 hours. While the hours mentioned above are one-time, given that you only buy the property once, given the hours we spent turning over our property between tenants, I think that one can safely assume that the same number of hours is a good average, or expectation each year.

So now, the question is how much time, or better yet, what kind of time does one want to spend to get this magical fun money? If it’s worth 24 hrs of your time at $25/hr, then the house is the better option. If not, if your time is already stretched and you need something that is more of a set-it-and-forget-it, then the index fund might be the better option.

Knowing how much time my wife spends between managing Stella’s Laundry and Car Wash, working her part-time job, and taking care of our household while I’m travelling for work, I think that the index fund will be the better option.

Also, she might want more than $287 worth of stuff.

Post Script: After reading this analysis, my wife said: “I’d just ramp up my wash & fold side hustle for the extra money”.

*Cash flow is the net profit determined after subtracting all expenses including: mortgage, taxes, landlord paid utilities, maintenance & repair, property management, and whatever vacancy rate you use. I generally use 10%, which is a little more than one month per year.