(Meta-note: 100th post!)
I was having dinner with a friend recently, and at one point we started reeling off the “obvious” pithy financial wisdom we knew. Things like “spend less than you make” “invest in index funds” “avoid fees,” etc. At one point, she also continued, “pay your car insurance up front.”
Ahh. Umm. Right. Of course.
I then had to admit, embarrassingly, that this was something I didn’t do. An admission that led to some soul-searching on what things truly cost, and why it’s not always just about money.
Table of Contents
The situation is thus: Many car insurance plans (though this practice isn’t limited to car insurance) will allow you to pay each month or, alternately, every six months (or even every year). When summed over the course of the year, the prices of these plans are not equivalent: the pay-per-month plan is usually slightly more expensive than the pay-per-year option.
In my particular case, the pay-per-year option is $90 more than a year’s worth of pay-per-month payments. And because I opted to choose this latter option, I am willingly paying $90 more than I have to.
But wait! There’s another calculation at work here.
How to pay a yearly bill each month
I determine my budget on a monthly basis (and recommend you do as well). A giant bill that comes every six months or a year would dwarf my ability to pay it. (If you don’t see this, imagine a month where your expenses would suddenly be reduced by hundreds of dollars. It would never work.)
Now I could just save up the money in my account for the six months or a year, and then I’d have the money when the huge bill came due. But then the issue becomes that my level of account float would necessarily change each month. A fluctuating float value seems like it has the potential for complicating an already complicated situation.
If this is confusing, here’s a example that shows why:
With a standing float value of $1000, and $1200 yearly bill, you would have $100 extra dollars of float in your account each month. So in month #2 your float would be $1100, month #3 $1200, all the way to month #11 where you would have $2100, and then month #12 when your bill would be due, you’d be back down to $1000. And this is before you’ve taken bills or expenses into account. See? I’m confused just writing this.
One possibility is that I could “pay myself” each month, but into another fund (like an online savings account). Then my float value would remain the same, but I’d still have the money for my giant bill when it came due. Now this seems like the most promising option, but it still suffers from the complexity factor: I would need to manage another account, and have to set up and manage both incremental deposits and a periodic large withdrawal. This seems like a lot to manage.
The point here is to compare the extra money you would have to pay with the complexity you would introduce by working around it. For me, the time/energy cost of setting up and managing a separate sinking fund for my car insurance payments is greater than the money I save by paying my insurance in advance. In other words, I pay $90 a year ($7.50 a month) for the privilege of not having to manage a separate fund. $7.50 a month for simplicity.
The balance may tip
Now, what if the difference wasn’t $90 for the year, but $900? Then you’re darn tootin’ that I’d be setting up a separate account. That’s worth the extra complexity to me. But right now, the difference isn’t worth it.
I admit that I’m still a bit embarrassed to say that I am technically paying more money for something when I don’t have to. And I’m reevaluating this, just like I periodically do with all my bills.
But it’s not always merely a decision of “how much” versus “how much per month.” It also includes “how much work” and even “how much complexity.”
As for what to do when you encounter a situation like this in your life? It is usually best to choose the option that costs the least amount of money over the long term. But don’t always discount the option that allows for more simplicity.
Or am I just copping out here?
But enough about me, do you spend more money to simplify?