Do You Overlook the Indirect Costs?

Posted by Jill on February 1, 2010

Leading up to my CFP(R) exam last fall, I set a little aside from several paychecks to save the total amount of my registration fee. When I registered, I depleted the entire amount I had saved – but the registration wasn’t the end of my exam-related expenses.

I forgot to take into account the $120 worth of study materials I had to purchase. Or the several extra meals I ate out in the weeks leading up to the test. Or the two times I let food spoil because I was so distracted by studying I didn’t put it away after cooking.

Basically, I did everything right by planning ahead and saving for a large expenditure – but forgot to include the “indirect” costs when deciding exactly how much to save. If you’re saving up for a big purchase in the upcoming months, make sure to consider the full cost.

Why Full Cost Matters

I’m constantly telling people that they should plan ahead and save for the things that they know are coming up. But your savings plan is only as good as the accuracy of your goal amount. If you’re saving up for a $1,000 vacation that ends up costing $2,500…you’re in trouble. During the holidays, I advocated that you include entertaining costs and party contributions to your holiday budget, instead of just considering gifts. Using that same principle throughout the year will help ensure that you always have the cash you need at the time you need it.

Extra costs can have huge implications when making major purchases such as a car or a house. Many people figure out the maximum mortgage they can take on – and forget to include taxes and insurance. Ditto for buying a car and forgetting about title/license costs. The point is, these things matter – and you must take them into account before deciding you can afford something or setting a lump-sum savings goal.

When Indirect Costs Can Save You Money

Considering the full cost of a financial decision can go both ways – it can stop you from making a purchase you thought you could afford, or help you realize that you can afford something that seemed out of reach.

When I was considering moving to a more expensive apartment, I was tempted to skip it even though I loved the layout and could walk to work. A less-nice apartment in a different part of the city would run me about $150 cheaper per month. But then I realized that by living in the more expensive apartment, I would have zero commuting costs – saving me, you guessed it, about $150 per month.

When considering where to live, the full cost of my choice included rent AND commuting costs – by recognizing that, I was able to choose the nicer, more expensive apartment and still feel that I was making a sound financial choice since I was breaking even but saving at least an hour of public transportation each day.

Preparing for the Extras

In my everyday job, I work with clients who have to submit a budget request ahead of time for large projects. They don’t necessarily have 100% accurate estimates at the time they do their budget. So instead, they budget as accurately as possible and then add a “reserve” of anywhere from 5-15% depending on the total size of the project.

If you’re preparing for a purchase and are just not sure of the extra costs, you might consider doing something similar. Sometimes you really can predict the extras if you just take the time to consider all the moving pieces. In a case like my exam, I had no way of predicting just how many hours I would end up studying, and how I’d have to make time for those hours by spending a little more on convenience items. Nevertheless, I should have known that some extras would creep up.

If you save more than you need, you can always redeploy the extra funds into debt payments, other savings goals, retirement plans, or even a nice dinner out or other treat. But if you find yourself with the need for more cash, it’s not always so easy to come up with that cash quickly – especially if your omission was on a large-scale item such as a house or car. By considering and planning for the full cost of every planned purchase, you can make sure that you never find yourself in a budgetary bind.

Editor’s Note: I’d like to congratulate Jill on passing her CFP! She didn’t mention it, but all that studying paid off, even if she did spend a little more on eating out. Congratulations Jill! – Madison





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Comments to Do You Overlook the Indirect Costs?

  1. Excellent column. I have a lot of life experience but you presented some new and interesting ideas. Would you please send this to every member of Congress, the Pentago, and every Government agency that puts forth a budget?

    Rory Rohde

  2. Great topic that is rarely mentioned or considered. This also goes along the lines of opportunity cost where people don’t take into account what they could have gotten otherwise. For example, someone may think of their situation if they were to buy a new car or keep the old one but not take into account if they had invested the money they would have put into the new car into their retirement.

    Edwin

  3. Great post! I used to do that with Christmas. I would budget for gifts, but not for the cards and postage, teacher gifts, extra baking, parties, etc. I think all these came close to our gift budget. I am sure that you are helping someone.
    Congrats!

    Lisa

  4. At work when I do cost estimates, I always pad it with a 10-20% contingency. I do the same thing at home when I budget for things. That is why my husband never trust “my numbers.” But hey, we haven’t run into a problem yet for having a little “extra” budgeting this way.

    asithi

  5. Thanks for all the comments!

    @Lisa yes, I think Christmas is the most common culprit – you try to be SO GOOD by coming up with a plan, but inadverdently leave out all the little extras. Cars are a big one and entertaining – you plan for the food and drinks, but not the paper goods and things like that. It seems like you recognized the problem and changed your budgeting – hopefully other people do the same 🙂

    @asithi Yes, that is a vety good plan, especially when you just have no way of knowing how much something might cost you. Like you said, having a little extra never hurts – all the better to pay off debt or throw into savings if it’s left over later.

    Jill

  6. My rule of thumb is to estimate the amount you will need for a project or purchase, and then at 1.3% to it because we always underestimate or forget about an extra item when calculating the costs.

    ParisGirl111

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