Imagine a set of twins, a boy and a girl, raised by the same parents. They went to the same high school and both graduated with high GPAs. They both earned Bachelor’s degrees, graduating with honors. One went on to earn $250,000 as an engineer. The other earns $50,000 as a school teacher.
Fast forward 15 years…
The engineer owes tens of thousands on various credit cards. He has refinanced his house several times to pay them off, so he has no home equity. He has no emergency fund and no retirement savings. The teacher is debt-free, has a fully funded emergency fund, and invests 15% of her gross salary in a Roth IRA.
The engineer will have to work until he dies. The teacher will retire with dignity with millions in the bank.
How is it that someone with a high six-figure annual income can be broke while another making less than half as much is on solid financial ground.
Answer? The teacher learned early on about Dave Ramsey’s Baby Steps and has power over purchase. Here are Dave’s five steps she follows.
1. Wait overnight.
Waiting overnight prior to making a big purchase helps the teacher know whether she really “needs” to make that high ticket purchase. Is this new iPhone Xs Max really worth the price? If the phone she has works now, she will be less likely to buy the new one. And if she does, she’ll pay cash.
Meanwhile, the engineer believes the salesman who says, “This one-of-a-kind beauty is the last one I have, and I don’t know we’re getting more.” The brother bites, and drives off with endless payments on a guaranteed-to-depreciate asset.
2. Know your why.
Our teacher friend know why she’s shopping for a new purchase. For example, she knows that a car ultimately just gets her from point A to point B safely. She looks for the best price and maintains walk-away power.
Meanwhile, individuals like our engineer friend typically fly by their seats of their pants. They often make snap decisions to spend money they don’t have to buy things they had no intention of buying at the beginning of their trip.
3. Never invest money on something you don’t understand.
The teacher also avoids spending large sums on things she doesn’t understand. Her investments include things like ETFs or solid companies like Verizon and Coca-Cola. She routinely balances the asset allocation of her ETFs and stick portfolio. This system makes sure she buys low and sells high.
Meanwhile, the engineer is always swinging for the fence. He got in on Bitcoin at its peak. Because he didn’t understand cryptocurrency, blockchain, and data-mining, he invested at $18,000 only. Within months, his investment tumbled to $6000 a few months later. To avoid losing more money, he reasons he’ll cut his losses. That’s buying high and selling low.
4. Understand opportunity cost.
The teacher saves up and pays cashed for family vacations. No credit card debts for her, just great memories. Plus she knows that the $5000 spent on the vacation can’t be invested.
Meanwhile, the engineer brother pays for vacation with Visa and MasterCard. He may understand opportunity cost by joking that the family cruise was Junior’s freshman year of college. (I’ve been here, done this, and got the T-shirt!)
5. Know your “number.”
The teacher sibling has a pre-set amount in mind. For her it’s $100. Before she will spend $100, she will follow steps 1-4. There’s nothing magic about the $100. For some people it’s more. For others it’s less. Whatever it is, it’s a predetermined amount based on the written budget.
Meanwhile, the engineer sibling has no clue how much he is spending, because he has no written budget. So there’s no amount that triggers red flags for him. He simply has a “hunch” about whether he can afford the payments.
So follow these steps, and you will soon be taking power over purchase. Power over purchase is how people in good financial standing win with money.