The Ripple Effect of Making Big Purchases

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Our apartment lease is ending in September, so we’ve been on the hunt for a new place. Our current 1 bedroom place has served us well, but the time has come for a bit more space. In case you didn’t know, the Bay Area rent prices are insane. It does seem that prices are trending downwards slightly due to COVID-19.

With moving comes a wishlist of features we’d like the new place to have. Of course we won’t be able to check off every box, but we’re trying to hit as many of those boxes for the best value possible. While we’re continuing to rent for now, viewing all these different listings has made me think about the ripple effect of making big purchases in our lives.

I think people often overlook this ripple effect that big purchases have on their budgets, instead fixating on the sticker price. Advertisements harp on this as well, talking about “low monthly payments” and “no money down.” Our consumer culture tells us that if we can afford the payments, we can make the purchase. Unfortunately it’s not that simple. Big purchases tend to cause a ripple effect that goes beyond the sticker price.

Example #1: Ripple Effect of Purchasing a New Car

Let’s take cars for example. Let’s say you’re an average American, who buys a brand new $35,000 car. Various sources have said the average car loan is $30,000 for 5.7 years, with payments of about $500. If you’re like most people and think, “I can afford a $500 payment per month,” you’re severely hurting your financial flexibility and failing to consider all the other costs involved, including:

• Interest – the average interest rate for car loans is 4%, so for a 5-6 year loan you’re looking at $3,000-4,000 in interest.
• Depreciation – According to Nerd Wallet, the average new car loses at least 20% of its value after the first year and then 15-18% per year after that. So after two years, you’re likely looking at over $10,000 in depreciation.
• Increased insurance costs – New cars mean higher insurance rates
• Maintenance – You’ll likely spring for more car washes, waxes, and higher priced oil/gasoline

Additionally,  the increased costs aren’t just financial – you’ll spend more time stressing about keeping it in pristine condition – for example parking further away from other cars and worrying about every small ding or scratch. So over the life of the loan you’re looking at a total cost of nearly $40,000 for a car that ends up being worth half of that.

Example #2: Ripple Effect of Buying a House

Houses are another great example of this ripple effect in action. The rent vs buy argument can get touchy, with many homeowners saying that renting is “throwing money away.” When evaluating whether to buy a house, they often just compare what their mortgage would be vs what they were paying for rent. Unfortunately, it’s not that simple. When buying a house there are many other factors to consider, other than just the mortgage payment, including:

• Interest
• Property taxes
• Repairs/maintenance – experts recommend setting aside 1-5% of the home price each year to pay for repairs and maintenance
• Home owners’ insurance
• Other fees – Closing costs, realtor fees, HOA fees, PMI, etc.
• Increased utilities – A larger space means higher utility bills, such as heating and cooling

With increased space also comes the temptation to buy more possessions or upgrade existing ones. Owning also means you’re on the hook for any repairs, maintenance, and yard work for your house. While my wife and I are planning to buy real estate someday, simply looking at the mortgage payment without considering all the other costs associated with home ownership would be a huge oversight.

The Diderot Effect

Now I’m certainly not saying you should never buy a house or car – far from it. My point is simply that large purchasing decisions have a ripple effect that go far beyond the payment price.

This ripple effect is often called the Diderot Effect. James Clear tells the story well, but to summarize, famous French philosopher Denis Diderot lived nearly his entire life in poverty. He ended up selling his library for a huge sum, the equivalent to $50,000 in today’s dollars. After this sale he bought a beautiful scarlet robe. In fact, it was so beautiful it made all his other possessions look ordinary and out of place in comparison. Soon, he began upgrading item after item.

This became known as the Diderot Effect, which states that obtaining new possessions often leads to a spiral of more consumption which leads you to acquire more new things. As a result, we end up buying things that we previously never needed to feel happy or fulfilled.

Final Thoughts

When evaluating purchasing decisions, we need to be conscious of the FULL cost. Beyond just the sticker price, we need to consider all the underlying costs as well. Most of the time, big purchases cost more than we initially think. We also need to be careful to avoid becoming like Denis Diderot, where one upgrade leads to a spiral of additional consumption.

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