Spend or Invest? New Thoughts on An Age-Old Dilemma

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Peter Romano, CLTC Ameriprise Financial Services, LLC.

A familiar experience for many Americans is that as fast as money comes in, it goes out the door again in pursuit of the next “must have” purchase. Such spending habits can take a toll on plans to build up savings for the future. The key is finding a balance between immediate gratification and long-term financial security.

People are juggling daily expenses, household bills, and rising costs of consumer goods. But the bigger challenge often comes when it is time to make a major purchase – a home, a car, appliances, or home improvements. When it comes to major purchases, when is the expenditure worth it, and when is the cost too prohibitive relative to your financial future?

Judging the “real” cost

There are a variety of ways to assess the financial value of a major purchase. The approach you choose can vary depending on the type of expenditure you make. Here are three ways to think about it:

1. Opportunity cost

Whenever you’re making a significant purchase on a product or service, you need to look at how it will impact your financial future. It is important to assess the opportunity cost of making a cash purchase today. For example, consider what could happen if instead of spending $5,000 on an extravagant vacation, that money was invested for 20 years earning 7% per year. Over that period of time, that $5,000 could grow to more than $19,000 (not accounting for taxes or investment fees). Assessing potential opportunity cost is one way to better evaluate the real cost of making a significant purchase.

2. A “return on investment”

Another consideration is whether there is a payback on the purchase. For example, paying for a class or a college degree may provide a future return in the form of the potential for increased income. Anybody who has spent (or taken loans for) $100,000 or more for a medical or law degree likely does so with a reasonable expectation that future income will more than make up the difference. A home improvement may be looked at in the same way – an investment that may be recouped in the future.

3. Borrowing the money to cover purchase costs

While it may be tempting to pay for purchases with credit cards, home equity loans or other types of financing, you have to think about how much borrowing the money will cost in the long run. The key here is to limit interest charges as much as possible. It’s not that you necessarily need to avoid all debt. In some instances, you can incur “good debt,” which is used to purchase an asset that has a long lifespan, increasing value and other potential benefits such as tax deductibility of interest. Mortgages and student loans are typically considered good debt.

Major expenditures aren’t just about the immediate benefit. You should consider whether the current cost would become more significant over time because the money was not invested for your future.

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Peter Romano, CLTC, is a Financial Advisor with Ameriprise Financial Services, LLC. in Bluefield, VA. He specializes in fee-based financial planning and asset management strategies and has been in practice for 30 years. To contact him, 276.326.1670 and 524 Virginia Ave Bluefield, VA 24605.

Investment advisory products and services are made available through Ameriprise Financial Services, LLC, a registered investment adviser.

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