TL;DR: when we look at our expenditure, it's easy to mix up day-to-day costs with capital expenses. It's common to make this distinction in business (Opex versus Capex) but it's valuable when it comes to our personal lives, too. We can also extend this more broadly: it might encourage us to put upfront time into projects which will save us a lot of time and effort over the long-run. Always look for clever Capex!
In business, it’s common to distinguish between operating expenses and capital expenses.
Operating expenses relate to day-to-day running costs. Capital expenses relate to expenses of more of a one-off nature, where the item(s) being purchased will last for more than one year/accounting period.
For the rest of this article, I’m going to refer to the two types of expenses as Opex and Capex.
It’s a useful distinction in business. It’s also useful when it comes to personal finances.
An example: buying a house is Capex
Let’s take a couple that usually spends about $60,000 each year to support their lifestyle. In a given year they spend $400,000 to buy an apartment.
In that year, you might say they’ve spent $460,000. But it’s useful to distinguish the $400,000 apartment purchase from their ordinary expenditure of $60,000. Their ongoing expenses of $60,000 are Opex. The house purchase was Capex.
(Okay, technically some of the $60,000 was probably Capex at a much lower scale, such as furniture that’ll last many years. But you get my point.)
In this context, Opex relates to their day-to-day expenses. Capex — their new apartment — relates to an expense that will keep providing them with a benefit from year to year.
Thinking of Capex in the context of Opex
When making decisions about Capex, it’s useful to break this expenditure down and think of it in terms of Opex. In short: think of your big expenses not as big expenses (which are a cash flow issue) but in terms of how much they will cost you (and save you) over their useful life.
This relates to bigger expenses, and also to smaller ones.
Below, I’m going to talk about this in the context of cars, rice, and computers. Then I’m going to talk about this mindset in terms of time.
Consider a car. The amount you pay for the car isn’t really the cost of the car.
If you plan on buying a car and holding it for three years, you’re likely to sell it when you purchase a new car. As such, a $30,000 car may seem a lot more expensive than a $15,000 car. If we assume 50% depreciation on each car, the net cost of the $30,000 car reduces to $15,000, and the cost of the $15,000 car falls to $7,500.
Thus, the difference in holding cost isn’t $15,000 (ie, the upfront cost of $30,000 compared to $15,000) but $7,500 (ie, the cost-less-trade-in of $15,000 compared to $7,500). In other words: the $30,000 car is “only” $2,500 per year more expensive rather than $5,000 per year.
(Of course, I’m over-simplifying. I’m ignoring other costs of ownership such as registration and insurance. There are also opportunity costs associated with the capital tied up in your vehicle: for instance, by putting $30,000 into a car you are foregoing the investment returns you might have generated from the additional $15,000 (or whatever) that you’d have been able to invest. On the other hand, there might be less risk and lower petrol and maintenance costs with the $30,000 car. You get the picture.)
Even if you replace your car every year, the cost isn’t how much you pay for the car. For instance, you might buy a new car each year for $50,000. When it comes to trade in that car when you buy another car the following year, you might get, say, $35,000. This means the net cost of the car is $15,000 — forgetting, of course, other costs such as registration, petrol, insurance, and the opportunity cost of investing those funds elsewhere. That’s still more expensive than buying a cheaper car, but it’s not as expensive as it first seems.
A characteristic of the house-or-car-as-Capex examples is that they relate to time frames spanning years, if not decades.
However, you don’t need to think in yearly time frames. You can use this perspective to think about purchases in the context of months or weeks.
Let’s take rice as an example.
Rice is a staple in the Bailey household.
Historically, we’ve only ever bought rice in 2kg bags. When we look at this through the Opex/Capex lens, this makes no sense whatsoever.
It’s much cheaper to buy rice in bags of 10kg or 20kg. Since I drafted this article, that’s what the Baileys have started doing.
Buying computers with higher specifications
I use computers a lot.
I don’t tend to replace my computers very often. It’s a hassle, and often very hard to justify. I generally keep my computers for roughly five years before upgrading to a new machine.
I might make minor changes to my computers. For example, I’ve been known to add ram and hard drives, and once or twice I’ve upgraded the video card. But I don’t make major changes like replacing my motherboard or processor.
I’ve never regretted the decision to spend more on a computer.
In fact, spending more on a computer tends to be more cost-effective when I think of it through the lens of Capex and Opex.
I recently bought a desktop computer with an i7 processor rather than an i5 processor. Part of the justification is that I hope to do a little more video editing. But a more significant part is that when I’ve bought a “top of the line” machine I have tended to been happier with it (and my life in general!), and kept it for longer than when I’ve compromised on the specs.
On average I might keep my computers for five years. But I’ve probably kept my higher spec machines for longer (say, six years) compared to lower spec machines (say, four years).
When I divide the upfront costs over a longer time frame, to work out how the Capex manifests as Opex, the higher upfront cost actually ends up cheaper. And I enjoy the experience of using the machine much more. It’s a win-win situation.
Opex and Capex in the context of time
The Capex and Opex mindset doesn’t need to be limited to money. It can relate to time as well.
Are there areas of your life that take up a lot of your time, that you could speed up, if you invested some time upfront to build a better process or set of systems?
(Yes yes yes, I’m thinking about things that don’t add value to your life… by all means, spend lots of time on things like sex. Now that you have more time, perhaps you can s-l-o-w down in that domain!)
This is especially the case if we are talking about things that you do day after day, year after year.
What can you do today, or in the coming weeks, that might take some time, but will save you time over the long run? How can you invest your time so you can reap rewards over the long-run?
It’s all about investing resources — whether money or time — upfront, to get more day-to-day benefit. It’s clever Capex.