How much can I afford?

Have you ever asked yourself, “How much can I afford to spend?” Let’s say you want to buy a new appliance or maybe a new game or game console or whatever. You have money in liquid savings for your six to eight months living expenses. (Note – Liquid savings is money that you have in a savings account that you can withdraw without any penalties for your immediate use.)

For this example, let’s say you have $5,000 in savings. The item you want to purchase is $661.30 including tax. Well, I have some rather bad news for you. You cannot afford to buy this item. A general rule to remember when consider a purchase is to purchase only an item that costs 3% of your liquid savings.  In this instance, the item you want to purchase is !3.23% of the $5,000 (661.530/5000=0.13236). Three percent of $5,000 is $150 (5000×0.03). You should limit any purchase to that $150. After you spend the $150, make sure you rebuild your emergency savings as quickly as possible.

Remember that you should also include a line item in your monthly budget for the repair and replacement of items that will breakdown or that you will need to replace, e.g. appliances. You should start by save at least 3% of your total income and slowly increase it to 5% and eventually to 10%. Don’t worry if you cannot afford to start with 3%. Start with whatever amount your budget allows, just start putting something away each month. This is the old “rainy day fund”.

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