How to Spend Money Wisely: Understanding Total Cost of Ownership

by TerriRexson

If you want to learn how to spend money wisely then it's important to understand total cost of ownership. How much does stuff really cost?

I want to get the most I can from my money. I hate wasting money. But it can be hard to work out the most effective way to spend money.

Should you buy cheap items that are easily replaced, or high quality items that will last a long time? Should you buy items that will save you money in the long run?

To understand this we need to consider the Total Cost of Ownership (TCO) of a potential purchase compared with alternative purchases. TCO is commonly used in business and is a worthwhile concept to understand in everyday life.

For many people making the money they have go further is more realistic than earning lots more money. By thinking long term you can improve your standard of living without having to earn more money.

How to Spend Money Wisely Series

This article is part of a series on how to spend money wisely. 

It's taken me a while to work out how to spend money wisely. I'll share my tips for making the most of your money, starting now.

What is Total Cost of Ownership?

Total Cost of Ownership or TCO measures the full cost of owning something. It includes the original purchase price, consumables and running costs. TCO is often used in business, but we can adapt it to domestic purchases to help us decide how to spend our money. 

If you can sell the item when you have finished with it then you can deduct that cost, although you probably won't know that in advance. 

If the item will save you money - like energy saving lightbulbs, or growing your own vegetables - then you can deduct the savings. For some purchases you'll actually make a profit. 

To be get a full picture of the cost of an item you should really account for the loss of the interest you would have earned if you had saved the money rather than making the purchase. This only makes sense for non-essential purchases. 

To compare alternative items that last different amounts of time, we can compare TCO per year (or other time period.)

Example: Total Cost of Ownership of a Second Car

Depending on your circumstances, the total cost of ownership of a second car can be very high compared to the benefit gained.  

I don't drive. Instead I walk, use public transport and take occasional taxis. Now and then I'll take a taxi over a fairly long distance at a high cost. People are always shocked by my extravagance! When I compare my costs with their costs of running a second vehicle, they realize who is actually being extravagant ...

When working out the TCO of a second car you must consider:

  • Cost of a car loan if needed (or loss of interest on savings)
  • Depreciation in value
  • Insurance and Tax (and any fines)
  • Maintenance
  • Parking (and parking tickets)
  • Gas

You can use a lot of public transport and take a lot of taxis without coming anywhere close to the cost of running a second car. 

If you can organize your life so a second car isn't needed then you can save a lot of money. We have thousands of dollars more in our savings accounts because we didn't have a second car. Paying $100 for a taxi now and then makes financial sense. 

Do Cheap Items Cost More in the Long Run?

 I have two boys who are close in age and of a similar build. I've found that it's cheaper to buy expensive pants for them than cheap ones. 

If I buy a cheap pair of pants for my older son, the knees are pretty much worn through by the time he grows out of them. If I buy a more expensive pair then his brother gets to wear them too. And I can sell them on eBay afterwards too - good quality branded kids pants keep their value. Now most of my kids' pants come from Gap

Let's run the calculations:

Child 1 Child 2 Sell on eBay TCO
Cheap Pants $12.50 $12.50 0 $25
GAP Pants $25 0 -$8 $17


So in this case the cheap pants worked out more expensive for two kids, and the kids get to wear better quality clothes. Even if I don't sell the pants on eBay, I break even and can donate a good quality item to a thrift store. Also because I know my strategy, I can try and think ahead and buy the GAP pants for the next season when they are on sale. 

At this point, you might be thinking, ooh I could do even better by buying the used GAP pants on eBay. That can make a lot of sense. For me with two boys, I know I'd rather have new pants and be sure they have plenty of wear in them. 

Of course this calculation will be different for different items. Sometime cheap items do work out cheaper. I don't actually do calculatations for most purchases, but I do try and think about these principles. 

Which Financial Mistake do You Make More Often?

Selling Items Can Reduce TCO

One good way to reduce the TCO of an item is to sell it as soon as you are done with it (as we did with the kids' pants above.) This is a tactic we use regularly. I buy a high quality item, knowing that it will command a good used price once we are finished with it. 

You can also buy the item used to reduce your initial purchase price. If the item still has some life in it when you have finished with it you might be able to sell it again. 

This approach is very effective with a lot of baby and toddler equipment. I have sold strollers and baby toys. And I'm currently planning a clear out of reusable diapers, travel crib, baby carriers, high chairs and lots more. Items can be sold to friends and colleagues, at local baby sales or on eBay. 

Selling items to reduce TCO can also work well with expensive items that are only useful in the short term. Perhaps you buy a really good bike for a major trip, but afterwards you realize that you're not going to get good use out of your bike back at home and a much cheaper bike would be fine. Sell the expensive bike as soon as possible and buy a cheaper bike. 

When renovating our kitchen we needed a freestanding dishwasher temporarily. Having checked resale prices, we bought a good brand new and then sold it for a good price a few months later. We would have made a bigger loss on a cheaper dishwasher. 

Buying items that are likely to retain their value and have a good resale value can help you save money over the long term. This can be a good strategy if you're not certain that an item will get used. Will you really use that kitchen gadget or exercise machine? Make sure the item you pick will sell for a good price used if you're plans don't work out. 

Do You Have Lots of Stuff You Don't Use?

Buying Items that Save You Money

There are some items that you can buy that will actually save you money over the long term if you use them regularly. For these items you need to factor in the money saving into the TCO. But don't forget the cost of consumables, electricity and any other costs you incur. And remember you actually have to use the items to save the money. Just buying a mini greenhouse won't help - you have to actually grow the tomatoes!

Examples include:

Updated: 04/13/2012, TerriRexson
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Share your TCO successes and failures

BrendaReeves on 03/08/2013

I recently came to the conclusion that it pays to buy better quality items. That's after a pair of cheap eyeglass frames broke. I noticed that a very expensive pair of frames that I bought eight years ago were still in good shape. I also noticed that the pair of expensive winter socks that I bought seven years ago are still in good shape. I love to read. I offset the cost of books by selling them to a used book store. Great article.

katiem2 on 04/29/2012

I both buy far to many items of clothing, shoes, etc and just give them away to rid up the place. I'm working on spending less and being more aware of the money in verses money out. I live within my means and yet that can often be cut way back and applied more to savings. Thanks for the insights on money.

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