Save or Splurge? 4 Questions to Ask Yourself Before You Spend

By Markets Fool.com

We hear a lot about the importance of saving money, be it for retirement, emergencies, or college. But there comes a point in life when we deserve to enjoy some of our earnings. Whether you've got your eye on a new car, an upgraded TV, or a luxury vacation, it's natural to want to spend a portion of your hard-earned money on some form of instant gratification. And you should treat yourself to that coveted item or experience -- as long as you can really afford it. Here are four questions to ask yourself before you indulge.

Continue Reading Below

Image source: Pixabay.

1. Is my emergency account fully funded?

You never know when an illness or layoff might leave you without an income. Even a short period of unemployment could wreck your finances if you don't have an emergency fund in place. If you're single and don't own a home, aim to have three months of living expenses in the bank. If you're a homeowner or have a family to support, save enough to cover at least six months' worth of expenses. Only once your emergency account is fully funded should you consider spending a large chunk of money on something nonessential.

2. Am I on track for retirement?

Once you have ample emergency savings, your next goal should be to start socking away money for retirement, and the sooner you start, the more time you'll give your money to grow. According to Fidelity, you should aim to have saved the equivalent of your salary by the time you reach 30. By age 40, you should have three times your salary saved, with the ultimate goal of accumulating 10 times your salary by the time you retire. What this means is that if you're 40 and earn $80,000, ideally, you should have $240,000 in your retirement account already. Now if you're thinking that $240,000 sounds like a lot of money, well, it is. Fidelity's guidelines are good to aim for, but for many of us, they simply aren't feasible. That said, if you're 40 years old, earning $80,000 a year, and only have a $10,000 retirement savings balance (or, worse yet, no balance at all), it means you have some catching up to do -- so that new sports car will just have to wait.

Continue Reading Below

3. Can I pay for what I'm buying in full?

When you use your credit card to finance a purchase you can't pay for outright, you always end up spending more on whatever it is you're buying. That's because credit cards charge interest, and then compound that interest so that over time, you end up paying interest on top of that interest. (Shall we say "interest" one more time?) Let's say you're looking at a $2,000 sofa. If you pay for it in full, you'll wind up spending just $2,000. But if you use your credit card and take eight months to pay it off, you'll end up spending over $2,100 if your interest rate is 14%, which is pretty much the average these days. If you're wondering whether to buy something new, ask yourself if you have the money to pay for it up front. If the answer is no, hold off and move on.

4. Is there something more important or satisfying I'd rather buy?

There's a difference between what you can afford and what you should afford. You might have a fully funded emergency account, a decent retirement savings balance, and an extra $5,000 to boot. But that doesn't mean you should jump to spend that $5,000 on gadgets or an exotic cruise. Rather, think about what else it could be buying you. Are you hoping to own a home? That money could go a long way toward a down payment. Has your car seen better days? A functioning vehicle is far more critical than a new entertainment center. Don't just think about the things you can buy; think about what you won't be able to buy if you spend your money elsewhere.

Here's another thing: If you take the money you're looking to spend and invest it instead, you might generate enough of a return to meet multiple goals. Say you're thinking of buying a $5,000 patio set. If you hold off, invest that money in stocks, and generate an 8% return (which is actually below the market's average), in two years, you'll have an extra $800 to spend, save, or reinvest.

When deciding whether to spend versus splurge, know that there's often a middle ground. Sure, you deserve a nice vacation, but you don't have to blow $10,000 at a luxury resort to relax and unwind. Spending just $2,000 might give you the experience you're after while leaving you with $8,000 for more important things. There's no harm in treating yourself, as long as you do so wisely.

The article Save or Splurge? 4 Questions to Ask Yourself Before You Spend originally appeared on Fool.com.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.