Saturday, 26 July 2008

A Better Value Proposition

Y'know, some might say I have some really weird ideas about money...

Thing is, they're ideas that are ever-evolving, and they're ones that work for me. Maybe they'll work for you too. I can't tell. You'll have to decide for yourself and realise that these are *ideas* not advice, and therefore, DON'T SUE ME!

Here's a thing though: I had a conversation with a friend today, and it got me thinking about a few things, including a web site I was reading yesterday. It talked about a saving concept called "Value Proposition". It's when you make a decision to save or spend based on whether it's a better "Value Proposition" to do the one or the other.

Here's a personal example from our discussion this morning:

We have debts from our business, and we also recently bought a house. 

I've figured out that the best thing for us to do will be to consolidate those debts onto our mortgage. Logical and normal enough thing to do, you might say, but this has a bit of a twist: the bank just told us our house needs to be worth around $10,000 more than its current valuation for us to cover the consolidation.

What to do? Well, I have around $1000 left over from a design job I've been doing, and I've been wondering what to do with it. 

My first thought was to save it. In my high-interest online saver account, it'll make me around $8 per month... The other part of that plan was to use it to cover the instalments on a course I'm doing in money management and investing. Even at $200 per month (and with me trying to save the same out of my pay to reduce how fast and how much I withdraw, but having that $1000 there as a backup for when I need to use my pay to cover, say, the car being serviced one month), I'd still be getting something for my money...

Then the problem of the consolidation came up. Crap. What do I do?

Well, if you saw the pic of our house above, you'd understand that it's not very impressive from the outside. We've done a heap to the inside, and that's already added value, but it's not enough... soooo....

I did some calculations, and figured that if I spend my $1000 on jazzing up the outside of our house, it should give us enough boost to add $10,000 to its value. The whole 10% rule thing (which I'll talk about somewhere else later). For that, and with a bit of work, we could fix the garden up, probably the fence too and, surprisingly, afford to repaint our exterior in a colour scheme other than "boring". That will definitely boost the value!

"But why don't you just throw the $1000 at your debt and reduce that straight away?" asked my friend. "You'd save yourself a whole lot of extra work at the weekends" she added, pointing out that the project I've just worked on to make the money has already left me with a sore back and a bad cold. "You'd do better to take on some extra work at home," (since we have a baby and I can't get enough day care to go work full time) "...and use that to pay down your debts", she added.

I thought about this, and argued a big point:

The money I throw at my debts doesn't cover the bit that's actually about to cause a real problem. Not only that, consolidating the loans will actually save us something like $19000 in interest, and I'd rather not have to pay out extra money I don't need to. Thinking back to that web site and it's article, the best way to describe the idea of simply paying off the debt with the money was that it was a Bad Value Proposition.

When I got home and had a bit of a ponder over the washing up, I thought about what my friend said. Perhaps she could be right and I was missing something?

But on further examination, the proposition of putting all the money I earn from extra work onto the debts looks like and even worse proposition to me. With a little one who needs her Mum around some of the time, I need to work smarter, not harder, for my money!

I'd have to work another three days a week (that's six days total, folks) to even make an inroad into that debt. Of course there are other factors affecting that figure, but they're not important here.

Why not spend the money and a couple of weekends working, even with a cold, to get the benefit that will allow us to pay it all down a lot faster (this assuming that we continue to pay the same amount off per month as we are now, before we consolidate)? That's a Better Value Proposition (BVP)...

Plus, if you think about it, it's making the money work much harder for us if it's spent on improving our house, than if it goes to feed a money-hungry bank. How? Here it is in point form:

  • We already know it will probably add enough value to our house to allow us to consolidate our debts.
  • Remember the debt is already there, and it's going to cost us $19K in interest (money that's doing nothing but pay the bank for the "privilege" of borrowing about half that amount of money) at the rate we're going. So really, by spending $1000, we're gaining $19,000. Sound like a BVP now?
  • Because the debt is already there, were still gaining another $10,000 value on our house, because we're only moving the debt, not spending more. That's $29,000 of actual gain.
  • "But," you say, "you're adding to your mortgage...". Yes, that's right. But we're also going to continue to pay the same amount we were paying every month onto the mortgage as we were onto the credit cards. Given that we're saving $250 per month off actual interest repayments, we're actually paying that in as extra repayments. I went to one of the best mortgage calculators out there and added that in as a split fortnightly repayment of $125 over the life of the loan. It saved us a gobsmacking $150,400 in interest, and shortened the life of the mortgage by 9 years, 8 months.
  •  So add that to the $29,000 we've already gained, and we're actually saving $179,400 over the life of our mortgage. I couldn't believe it!
  • Another interesting point is that if I'd gone the suggested route and put the money on the debts, I still would have had to find the money to fix up the house later on. Honestly, while the place isn't falling down around our ears, it still needs upkeep, and it's ready for paint, the garden fix, new gutters etc... I'd still have to find another $1000 to pay for the work I plan to do on the garden, and then the rest. This way, I'm getting my garden fixed and saving $179,400, just for spending $1000. Actually, I'm also saving that extra $1000 I'd have to have found, so make that $180,400!
  • Putting the credit cards into the home loan also frees up extra money we make later to either a) pay down the home loan even faster (saving incalculable amounts of money) or b) add value to the house by improving it or c) both!
  • And it mustn't be forgotten that a value proposition can also have an emotional and practical reason for being better value than simply paying one thing off. As if the argument wasn't good enough already, I get fivefold benefits personally: 
  1. I get to stop coming home to the truly depressing sight that is the front of my very practical and downright ugly/boring house... instead coming home to a view from my driveway that I can enjoy!
  2. I get to spend a little more time exercising and out in the fresh air than I used to - both while working on the job of fixing the view, and maintaining the garden later.
  3. I feel more inclined to spend leisure time outside because it's more inviting and...
  4. It's safer, once the job is done, for our little daughter to be outside and playing in the garden, because part of the process is removing some dangerous plants and nasty-for-baby-to-play-with debris!
  5. I get to spend more time with my daughter because I don't have to work nearly as hard to cover the repayments in the long term.
So, if I haven't managed to illustrate the sense of spending money instead of "saving" it (under certain circumstances), I don't know what will do it! 

Remember to think carefully before you save or spend your money - you might find that the spend is a much Better Value Proposition than you thought!

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