Can I afford it?

How often do you ask yourself “can I afford it” when buying something?

And how do you answer it?

Do you run the numbers? Or go by gut feeling?

And if it’s a joint purchase to be made with your partner, do you discuss it and take the decision together? Or just do it, and deal with the consequences later?

Lately this question of “can I afford it” has been on my mind a lot, both because I often hear it in coaching sessions with my clients, and because Carlos and I are in the market for the largest purchase of our lives: a new home in Amsterdam.

So, I thought I’d share my 3-step approach for determining whether I can afford something, from relatively small purchases such as new pair of shoes, to net worth changing ones such as a new apartment.

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#1: First things first, is it a need or a want?

Any purchase, big or small, can always be categorized in this way.

Why is it important to start here? Because this distinction helps focus the rest of the decision-making process, especially when trade-offs need to be made.

Needs are often no-brainers, and more so when they pop-up unexpectedly. For example, the washing machine broke down and you need a new one. Or your tooth hurts and you need a root canal asap.

In such cases, the good ol’ emergency fund comes to the rescue, taking the decision-making out of the process. You just do it, and then gradually replenish your emergency fund.

Wants are trickier, especially when we frame them as “needs”.

For example: I run often, and my current running shoes are years old, have holes in them and the sole is razor thin, so I need a new pair. But do I need the new Adidas shoes priced at 250 euro? Nope, I just want that new model.

There’s absolutely nothing wrong with wants, they’re what make life fun and colorful, and how we enjoy our money!

The point is that we are able to properly distinguish wants from needs, especially when determining whether we can afford them. It helps us stay flexible regarding when and how we buy them.

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#2: Will it disturb my cash flow?

Cash flow is how our money moves, what’s coming in and going out.

On a steady basis (say monthly), I want stability and predictability in my cash flow, assurance that I’m on track to hit my financial goals through saving & investing, and the feeling that I have breathing room.

What that means in practice is that I have money principles I follow and apply to my purchase decisions.  

An example of money principles I recommend clients to start with looks like this:

1. Max 70% of income on expenses (bills + discretionary spending), ideally less

2. Emergency fund in place, covering minimum 3 months of income

3. Costly debt being paid off consistently, costly meaning above 8% interest rate

4. Investing privately for 'future me' at retirement, at min 10% of income

5. Planning ahead for purchases in the short-to-medium term in ‘purpose saving funds’

Coming back to those 250 euro new pair of running shoes: if I can comfortably fit them in my expenses (i.e. they didn’t push me above 70%), or otherwise I save ahead for them, I can afford them.

And what about larger purchases, like that new apartment Carlos and I are looking for?

Same thing: if the monthly/yearly cost of that new apartment keeps us within our money principles, then we can afford it.

Here’s where the concept of Total Cost of Ownership (TCO) comes in handy: TCO means ALL associated costs with the purchase, one time and recurring.

In the case of the new apartment, recurring costs would be the monthly mortgage payments, the home owner association (VvE) monthly fee, the service fees, ground lease, property taxes, monthly utilities and repair & maintenance (regular and ad-hoc).

When deciding what kind of apartment we can afford (need vs want), we want to make sure all those costs fit within our money principles and do not jeopardize our saving & investing goals, now and in the coming years.

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#3: Does it clash with what I want the most?

This one is where we get truly honest with ourselves.

Sometimes when we really want something it can clash with something else we really want, and we simply can’t fit both financially in our lives, at least not at the same time. So, a trade-off has to be made.

In our case with Carlos, we want a 3-bedroom apartment in Amsterdam around Vondelpark, in a new building, energy label A+ etc.

And we also want to be financially independent (FI) by 50, meaning not having to work for an income if we don’t want to.

As you can imagine, these two wants are in direct conflict with each other: getting the dream apartment would significantly reduce our capacity to invest, and therefore delay our timeline to FI for many years.

“Can I afford it” becomes “should I buy it?"

Knowing the trade-offs and opportunity cost of purchase decisions, especially big ones, helps stop any analysis-paralysis and align our spending with our values.

Then the answer to “can I afford it” becomes so much clearer.