What would you do for a Klondike Bar?

If you’re nearly as old as I am you’ll remember the commercials from the 80’s & 90’s for the Klondike Bar. The delicious square-shaped ice-cream covered in chocolate. The commercials always asked, “What would you do for a Klondike Bar?”

The satirical, animated sitcom Family Guy did a version of that as well. Asking would you kill a guy? That just happened to be the commercial that snapped Peter out of his “no TV” moment after he was forced to watch tv while in a hospital bed.

The point of this is that the commercial is asking what are you willing to give up to get a Klondike Bar because they are so good you would go to the extreme to have one. Although you could just go to the grocery store and buy one yourself. So to get one, you have to give up something. That “Klondike Bar” can be a representation for whatever expensive thing you want in life, a new car, a new tv, a new big house you can’t afford, whatever you want to put in its place.

This is how Opportunity Cost works, at its most basic level. In some of my finance classes in college we discussed opportunity cost and ran the calculations for the time value of money taking into consideration the interest and time involved for compounding. We won’t get that complex here.

The point is to help you to think every time you are about to make a large, or maybe even a small, purchase. Whether it be something you think you need or just want. At a very low level it’s like when you go into Wal-Mart with the intention of buying just one or two things that you need, like milk and bread. But then while walking through the aisles you see something on sale or just something that looks really good at that moment, like a bag of M&Ms. Do you take a moment to think about your current financial situation? You may not give it too much thought for a candy bar, but maybe you do for that $50 item that is on sale for $30. If you are in a lot of debt you may take a moment to think if you really need that item, or would it be better to pay that $30 toward your debt.

Every time we choose to do one thing with our money or time, there is an opportunity cost. Meaning by doing this thing, we are giving up the opportunity to do something else. By purchasing that thing for $30 you are giving up the opportunity to pay down your debt by that amount. Or giving up $30 of food or whatever.

On a higher scale I’ll use an example of my friend. He was recently considering buying a brand new corvette. He’s single, has a high paying job, but always spends his money on having fun rather than investing. He can’t get over the fear of losing his money. The corvette he was considering is about $55k for the base model. (By the way, this is no different than many people in my area that buy huge trucks that also cost around that amount). He was planning to put $10K down and then have payments around $650/mo. I told him I thought that was a very bad idea and explained how he could invest it instead. Even though he can “afford” it, he would be literally throwing away money. Anybody considering buying any new car can learn from this lesson.

• Taking a side note here : I went into a car dealership myself a few years ago just to look around, no intention of buying and we did not. But the thing that got stuck in my mind even until today, was when the salesperson referring to my future payments, asked, “How much can you afford?” That really irked me because of what I know. I realize most people think that way and base their buying decision on that. But that is really not the way to think, that kind of thinking is what has caused so many people to be in deep debt and be struggling each and every month. Now back to the story…

If he were to purchase this car his first year he would be spending $17,800 ($10k down and 12 months at $650). Most people don’t put that much down so the rest of this scenario would be worse. That does not include the cost of insurance and gas which would be high for this particular car. Then each year after for the next 5 years or so another $7800/yr plus insurance, gas, and maintenance. The thing to keep in mind for a car is that it is NOT an asset. It does not produce income, unless you maybe use it for Uber or something. It is a liability and it loses value. In 10 years it will probably hold up its value a little better than a regular car but we’ll assume it will be worth about half of the purchase price. Another 10 years after that will likely depreciate faster since it is older so maybe 20% of the original price. So if he were to hold onto it for 20 years, not likely but for the example here we’ll go with it, the car would at most be worth about $11k.

After a “purchase” price of $55k with $45k of that financed with interest (we’ll assume 4%) and the “cost” of the depreciation in value, that car would have actually cost around $108k. (interest for 5 years around $9k + the $55k purchase plus the loss in value $55-11k). In reality most people exchange their car and buy another new one in less than 10 years which only compounds the problem since you are always paying a large debt for something that loses value.

Instead of buying that car, or any new car, you can instead buy a much cheaper car that meets your basic needs to get to work & school. No, it isn’t fancy and you may not look cool, but if you are wise and invest that difference, you can build wealth. So when you feel embarrassed about what you are driving, just think about your bank account and rewarding your future self.

Let’s stick with this same example. That $10k down payment and the 12 months at $650 = $7800, totalling $17,800. Let’s say you did one of two things. You either put that money into an index fund averaging about 6%/yr. In the 5 years it would take to pay off the car, keeping everything the same, we’ll say putting the $10k as a starting amount and $650/mo for 5 years. At 6% your account would be worth just about $59k. Then, keeping things the same, assuming you paid nothing more into the investment account, just like as if you stopped paying on the car and just let that money sit another 15 years, so after 20 years your total value would be around $144k. Obviously there are other variables we could add such as the additional expense for the insurance and gas and maintenance that you could add to that as well. But the point is by choosing that car which in 20 years would cost you over $100k and be worth around $10k at most, you gave up the opportunity to save and invest your money to grow it.

Another, possibly better, example is using real estate to grow your wealth. Let’s say you took that first year to save that $650/mo to keep building up your savings, you could even still invest in that index fund to grow it more in the meantime. Once you find the right property you use that money, we’ll say you’ve been able to save an even $20k, to put as a down payment on a great cash-flowing property. To keep things simple we’ll use a property purchase price of $100k. You put $20k down as a 20% down payment (you can get lower down payments) so you have a mortgage for $80k for 30 years at 5% making your payments around $430/mo. We’ll assume an additional $120/mo for insurance and property taxes. Your tenants pay all other utilities and pay rent of $900/mo. And for this example we’ll say you self-manage your property to save on property management expenses.

You get $900 in rent, you pay $550 for mortgage, insurance, and taxes. That leaves you $350/mo of additional income. One thing to keep in mind is that you also need to keep a reserve for maintenance and repairs since things will break or fail over time and need replaced. You could probably at least set aside half for that, but since you don’t “need” this money to live off you decide to just let it sit in your bank account and let it build so you can have it for future repairs or to buy more properties. (I prefer & suggest to buy more properties).

Now, this is where it gets interesting. Remember you were originally spending $650/mo for that car. You are no longer doing that. So instead you are saving that $650 and add it to the $350 cash flow from your rental giving you $1000/mo you are now able to save. You are now saving $12,000/yr. But in addition to your cash savings, you are building equity. That rental property is likely to appreciate in value, not depreciate like the car. And the tenants are paying your mortgage down which is building more equity for you. You also decide to be smart and put half of your new savings amount into an index fund to grow as well.

After 20 years your property is possibly worth around $150k, assuming a 2%/yr appreciation rate. Your mortgage is mostly paid off thanks to your tenants, remaining balance around $35k. Meaning you have equity of about $115k. PLUS you have been saving for 20 years. Remember you took half of the $1k and put it into an index fund and the other half in a normal savings account. Along the way you had to make some repairs and updates. Over 20 years we’ll assume about $20k spent on repairs. $500/mo in savings equals $6k/yr over 20 years is $120k minus the repairs equals $100k in cash in the bank. The other $500/mo you put into that index fund earning 6%/year compounding would be worth about $230k. So after 20 years you would have a net worth just from this one property of about $445k. In this case since we had the extra cash flows, you did not stop paying yourself after 5 years but kept paying the $500 into that index fund (referring to the original $650/mo paid for the car). We also did not include the expected rent increases over time. It is not likely that the rent amount will stay the same over 20 years so in reality you would have built up a lot more cash.

I would hope during that 20 years you were actually being smarter and buying another property at least every year or every other year to multiply the compounding effect. That is what I have been doing and it has been great. If you bought another similar, or multi-family properties every other year, you would have 10 cash-flowing properties, assuming an average of $500/mo from each you would be cash-flowing about $5k/mo most likely replacing your current job income.

So, back to the point of all of this, the Opportunity Cost. What does that cool car really cost you? Would you prefer to have spent over $100k for a cool car that is worth very little in 20 years, assuming you have nothing else of value giving you a net worth of about $11k. Or would you prefer to have a net worth around $450k, or more, with a cash-flowing property that can help provide additional income in a time of need. Not to mention many tax benefits it gives as well.

So, what would you do for a Klondike Bar?…

-By the way, just to give closure to the story of my friend. I maybe had a little effect on him. He did not buy the corvette. Instead he bought a different new sports car for about $35k with monthly payments around $410. Still not my idea of smart spending, but at least it is a little better. Unfortunately he also traded in a car he had on lease and therefore had to pay to get out of the lease so that amount got added on to the total.

Had he just bought one good rental, the cash flow alone could have paid for the car and kept paying him indefinitely. Something for you to keep in mind. I may do a post later on explaining how to use a rental property with the tax benefits to buy a car and consider the car as a business expense as well to be able to depreciate it and essentially get your car for free. In any case, please consult a tax professional for advice.