What Is The True Meaning Of Affordability?

Dissecting the definition of Affordability to learn its true meaning; to say confidently what you can afford.

True Meaning Of Affordability

You must have heard the phrase "I can't afford it" or "Can I afford to buy it." You say this phrase in several situations, and you do so intuitively. But, what does it mean to be able to afford something? Is there a way to put it in a formula that you can use every time you come across a situation where you have to decide whether you can afford it or not? I have been looking for Affordability's true meaning and have come across several different perspectives.

You do not have to think twice

One way to look at Affordability is M.J. DeMarco's way. According to the famous author of the bestselling book "The millionaire fastlane," M.J. DeMarco, you can afford something if you do not have to think twice before buying it. It does not affect your lifestyle, nor will you regret buying it if you lose your job tomorrow. For example, you will not think twice before buying chewing gum, nor regret buying it if you lose your job. Of course, you cannot say the same for buying a Mercedes or a Lamborghini. But, if you can, then you can afford it. So, in short, as per M. J. DeMarco, if you can purchase something in cash and do not have to think twice about it, you can afford it. It applies to everything you buy, from a private jet to a pencil.

Looking from a different lens

I do not share the same view as Mr. DeMarco on Affordability. I think one should keep M.J. DeMarco's idea of Affordability in mind; however, at the same time, one should consider their present situation and their income also. In a time when the credit is cheap, and the job market is ripe, one needs to adapt the traditional wisdom accordingly. This is why my idea of Affordability combines current low interest, high-income jobs, M.J. DeMarco's perspective, and Warren Buffett's ideology of evaluating a company. Let's understand each factor and how they combine together to create an Affordability formula.

Low interest and High income

You know that because of the pandemic, the government has printed loads of cash out of the blue to prevent stock and job markets from going into disarray. The government wanted to make this new cash readily available to companies and individuals at a low cost. This led to the historically lowest interest rates. In turn, it gave startups, and big corporations access to cheap money, which enabled businesses to expand rapidly. But, of course, to grow, companies need to hire people, which leads to several job openings. And like any other marketplace, the job market also follows the principle of supply and demand. So, with more jobs than talent available to fill them, it created an attractive job market with competitive salaries, increasing the average income. So, to conclude, we live in a low interest and high-income timeline.

The principle: Warren's way

You now know M.J. DeMarco's view on Affordability, easy access to cheap money, and increased average income; let us check the idealogy of Warren I am referring to. As per Warren, if a company can pay all its long-term debt from its income within 3–5 years, it is worth looking into. I took this principle and adapted it for me.

If I can pay all my long-term debt from my income within 3–5 years, it is worth considering taking that debt.

Understanding the principle

Before you conclude anything, the principle needs some explanation. But, let me first define the terms I have used in the above principle. First-term is the "long-term debt." Long-term debt is a debt that is longer than one year. Also, the debt is to buy assets and not liabilities. In case you are wondering what an asset and a liability are. Assets are investments that keep your principal safe and give you a fair rent in return. Liabilities are the things that eat your principal away over time.

Self-made Affordability Illusion

Now, let's check the second term, "Income." By "Income," I do not mean what you earn, but what you have in your hands after deducting all your expenses like rent, food, monthly installments, insurances, etc. For example, you have a single source of earning from your job. Let's assume you make $5000 monthly. So, $5000 is your revenue. You also have some expenses like taxes, rent, groceries, clothing, insurances, debt installments, etc. Let's assume these expenses to be $4000. Therefore, after deducting your expenses from your earnings, the amount you are left with is $1000. So $1000 is your income and not $5000. It is vital to understand this difference. Many people consider what they earn as income and fall into the illusion that they can afford something even if, in reality, they can't. I call it a Self-made Affordability Illusion created by individuals to make themselves happy.

I was a victim of this illusion and realized it when my wife and I started planning to buy a house for our family. So naturally, the first question that came to our mind was how much we could afford, which led to the journey to understand the true meaning of Affordability. Coming back, what I earn is my revenue. After deducting all the expenses from my revenue, I get my net income. So, the amount I can pay off using my 3–5 years of net income will be the maximum amount of credit I can afford.

Max credit = Monthly net income 12 Number of years (3–5)

So, continuing with our example, the net income was $1000 per month; therefore, I can afford to take 1000125 = $60,000 debt. Once more, the debt is to buy assets and not liabilities. If you want to purchase liability, I encourage you to go with M.J. DeMarco's formula. That is, you can afford to buy a liability only if you can buy it in cash without having to think twice.

I know the formula or M.J. DeMarco's view on Affordability might not make sense to many. But, don't worry; there is one more way to tell whether you are biting more than you can chew or not.

Will you become a slave of your lifestyle?

To know whether you can afford something, ask yourself the following question: Will you become a slave of your lifestyle after buying it? For example, if you buy a big house with a swimming pool, luxury car, expensive clothes, etc., and now you HAVE to work in a job you hate to maintain that lifestyle. That is what becoming a slave of your lifestyle looks like. In the worst-case scenario, if another pandemic occurs and puts your job at risk, what will you do? You have to put in extra hours to keep your job so that you can pay the mortgage, debt, and other expenses derived from your lifestyle. It will lead to increased stress and less time spent with your family and friends, resulting in poor relationships. This is the lifestyle of a modern slave. Hence, don't become a slave just because society approves it. Take control and be the master of your life.

With that said, these are different perspectives and viewpoints on Affordability. So, next time you wonder whether you can afford something, consider viewing it from these standpoints. It helped me make a decision I can be sure of; I am confident it will help you too.

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Disclaimer: The content is for entertainment purposes only. Please do not consider it as financial or tax, or investment advice.