The Most Important Money Decision You'll Make in 2022
This decision will make or break your finances
When personal finance Gurus talk about not buying coffee, I want to start screaming.
Yes, small daily purchases like lattes can have significant opportunity costs over a lifetime. But nobody became rich by cutting out their daily Starbucks (or Tim Hortons for my fellow Canadians out there).
This Tweet hilariously captures how stupid it is that we spend so much time in personal finance worrying about the small stuff.
Do you know what financial decision you should be focused on?
Where you live.
If you want financial freedom focus on housing
Housing is not only our largest expense, but it’s a fixed expense. Worse than both of those things is that housing is also the number one driver of lifestyle inflation.
Let’s face it; once you get accustomed to living in a 3-bedroom house, you’re not going to want to move back into a 500 sqft bachelor apartment.
In The Financial Freedom Equation, I break down the simple math to achieving financial freedom.
Financial Freedom= (Passive income + income from work you love) > Your living expenses
There are three variables you need to consider.
Passive income: aka income from investments.
Income from work you love: pretty self explainatory, money you make from pursuing your passions.
Living expenses: of which housing is by far our biggest expense.
Here’s the thing about generating passive income; it’s hard. It takes most people decades to build up enough passive income to cover their living expenses.
Making money doing work that you love is no picnic either. It’s taken me three years to build my passion project (writing) to a point where it can cover my basic living expenses. Building up my side hustle that quickly makes me one of the lucky ones.
The only variable in the financial freedom equation we can control is our living expenses.
High living expenses and, more specifically, high housing costs are what keep most people trapped in jobs they hate. The higher your housing costs, the further away financial freedom becomes.
Why? Because the higher your living expenses, the more passive income or side hustle income you need before it’s possible to break away from your 9-5. The opposite is also true. If you can cut back on your current housing costs, you are that much closer to financial freedom.
Don’t fall for the allure of McMansions
The most important Medium article I published in 2021 is titled “We Need to Kill the Idea of a Starter Home.”
Here’s the most important aspect of the article, where I breakdown the numbers of a family that I know who upgraded from their “starter home” to their “dream home.”
I’ll use the real-life example I mentioned above of a family who’s considering selling their $700,000 starter home for a dream house in the range of $1 million to $1.5 million.
The basic numbers.
First, you might be thinking $700,000 for a starter home!? Welcome to Canadian real estate. This home probably cost half as much 5 years ago.
Let’s assume this family has $200,000 left on their mortgage, which would give them about $500,000 in home equity.
I’ll split the difference and assume they land on a dream house worth $1.25 million.
The change in monthly housing costs.
To understand the increase in monthly housing costs, we need to consider how moving from a starter home to a dream house will impact the three primary costs of owning a home.
The mortgage payment.
Property taxes.
Maintenance.
I’ll assume a 2.5% mortgage rate on their current mortgage and their new mortgage in the dream house. As a rule of thumb, we can assume property taxes and annual maintenance both come in at 1% of the value of the home.
Let’s start with the monthly cost of the starter home.
A $200,000 mortgage on a 25-year amortization and a 2.5% interest rate would come in at $896. Let’s round it to $900.
Annual property taxes would be approximately $583 per month.
Annual maintenance would be approximately $583 per month.
The total monthly cost of the starter home = $2,066.
Now let’s look at the monthly cost of the dream house.
Applying their $500,000 equity to the $1.25 million dream home would imply a mortgage of $750,000. With a 25-year amortization and a 2.5% interest rate, the monthly mortgage payment would come in at $3,360
Annual property taxes would be approximately $1,041 per month.
Annual maintenance would be approximately $1,041 per month.
The total monthly cost of the dream home = $5,442
The difference, $3,376, is a 163% increase in monthly housing costs. Now, if living in a “dream house” is your #1 financial goal, and you earn a household income north of $250,000, you might be able to squint and make this math work.
Bringing this back to the financial freedom equation. Increasing your housing costs by $3,376 per month would mean that to be financially free, you would need a side hustle that generates $40,000+ per year or an extra $1 million invested.
Building a $40,000 side hustle takes years.
Building a $1 million portfolio takes a lifetime.
Not buying a bigger house than you need is a decision you can make right now.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.