In my recent post on the importance of creating financial margin in your life, I introduced the “5X Spending rule”. It’s the principle I use as a guide when purchasing non-essential items. My firm belief is that managing your spending on luxury items is an important aspect of building long term wealth. It’s a course of wisdom to ensure that the money you have tied up in non-cash flow producing items is a relatively small part of your financial world.
Whether you’re shopping at the mall or taking advantage of an online Black Friday sale, the 5X Spending Rule is a financial yard stick that quickly allows you to determine if you’re about to commit the equivalent of financial harakiri. I apply this rule whenever I’m about to purchase an expensive item that I want but don’t necessarily need. Stated simply, the rule goes as follows:
“If you can’t afford 5 of them, then you can’t afford 1 of them.”
For example, say that luxury watches are your thing and you settle on a $5,000 Grand Seiko. Unless you have the money (actual cash, not your credit card spending limit) to purchase 5 of the watches (at a total cost of $25,000), then you really can’t afford 1 of them. Applying this rule to luxury items, prevents you from having too much money tied up in things that aren’t growing your wealth. The rule also creates a mindset shift where more importance is placed on growing and preserving capital than on consumption.
The 5X Spending Rule also applies to small luxury items. An example I use often is Starbucks. I am probably going to get a lot of hate about this one, but hear me out. Sure, by my “5X Spending Rule”, I can buy 5 Starbucks lattes. Although affordable, this falls into luxury spending because there are plenty of other good-tasting alternatives that represent better value. A small luxury can easily turn into a large luxury habit when you actually add up the costs. This isn’t to say you can’t enjoy the occasional treat, but be mindful of what you label a necessity (food) or luxury.
The fact that this rule is a very simple concept, makes it that much easier to apply. A common reason cited as to why people are unable to start investing is lack of free cash. Regular application of the 5x Spending Rule over a several months practically guarantees you’ll begin building a cash war chest that can be used to cover life’s unexpected events. Don’t discount its effectiveness just because it is simple.
I’d love to hear your thoughts on the 5X Spending Rule. How difficult was it for you to regularly apply? Did you notice a significant reduction in your spending?
