Many people who are interested in personal finance topics have a love for numbers—perhaps they have an aptitude for math, or they study finance, or use numbers in their jobs. I, too, am a “numbers person,” someone who analyzes potential scenarios from a numeric perspective. However, my wife—educated as a musician—employs a very different thought process; her aptitudes are engaged when working with music, instruments and performances. We are both searching for early retirement and happiness, often from our unique perspectives. Since I prefer using numbers to review financial scenarios, I thought this might be a good opportunity to create a formula to calculate a Return on Happiness (ROH). This is a complex subject to tackle, to be sure!
What if one could come up with a formula that determines the best decision process for the use of our limited time and money? Is creating such a formula even possible? Is there an approach we could follow to identify, numerically, a “happiness factor”?
We know that, in the financial and accounting professions, there are hundreds of formulas to measure the financial health of a business. Examples include Return on Investment (ROI), inventory turnover, use of cash flow, return on equity, return on capital, debt ratios, price-to-earnings, and profitability. The list goes on. We could start with several rules of thumb in the personal finance space that are worth mentioning as a first step to creating a return on happiness equation.
Two common rules of thumb for the most expensive items in our lives
I learned that many of my perceptions about the wealthy were incorrect when I first read the book The Millionaire Next Door. For example, the author points out the size and cost of a typical millionaire’s home. Hint: it is not a mansion. I took away a rule of thumb that one should not spend more than twice his or her annual income on a house. If you are considering a home purchase of $300K, you should have an annual income of at least $150K.
Financial Samurai introduced a rule of thumb for how much car you can afford. He discusses this concept in his article on the 1/10th Rule for car buying : one should not spend more than 10% of his or her annual gross income on a car purchase. An example: a person buying a $30,000 car should be taking home $300K annually.
Creating a Return on Happiness Formula
Is it possible to use numbers to measure happiness? They say money can’t buy happiness, so maybe we should consider that having time could provide happiness. It really is two sides to the same coin. The book Your Money or Your Life (YMYL) touched upon a method to find “our enoughness” by reviewing how much and where we spend our money. The author explains the concept of determining your real wage per hour—after deducting all the expenses associated with your job—to arrive at your net wage. This can be a revelation for those folks who have not considered the cost of commuting, clothes, work lunches, and much-needed vacations in arriving at the overall hourly take-home pay of their jobs.
The author then calculates the true cost of an item: the net hourly wage times the number of hours necessary to work for that expense. The author recommends a monthly evaluation of expenses with the true cost in mind.
The chief cause of failure and unhappiness is trading what you want the most for what you want now. – Zig Ziglar
Taking guidance from that book, we will calculate the return on our time or money, evaluating it from a happiness perspective. However, first we need to define the components that make up the formula:
- The cost of the activity. What will the total cost be?
- Your net wage per hour. This is your gross pay, subtracting all of the costs of maintaining your job. For example, if you make $50 per hour, and you pay $12 in tax, $2 for commuting, $1 for food and clothes, and $5 in miscellaneous other stuff, your net hourly rate is $30. You can decide if you want to use the household earnings in a two-income family or only your own wage rate.
- Hours of work. This simple formula divides the cost of the item or experience by your net wage per hour.
- The quantity of happiness hours from the purchase. How many hours of happiness do you anticipate from the item or experience? Each item will have different hours, so make the best guess you can.
- Return on Happiness. A similar formula as presented in YMYL to determine the number of hours of work required to pay for this purchase. Up to this point, this is a typical ROI calculation used by businesses and PF people.
- Rate your level of satisfaction. Will it be a negative, neutral, or a positive experience? We are using icons respectively to symbolize various levels of satisfaction.
- The happiness factor. I have created and assigned an arbitrary rating to the purchase decision. Studies have shown that we are three times more likely to avoid pain than seek pleasure (this is referred to as “loss avoidance”). If the item under consideration does not provide much happiness, its rating will be cut by 50% in this model, while an item that provides happiness will get a 50% increase.
- The modified ROH. This is the result when you factor in your level of happiness attributed to the purchase.
No worries, we will jump into an example in which this will all come together.
Note: The ROH is for discretionary spending purposes—when you have all the other elements of your personal finances covered. Those elements include: having an emergency fund in place, regular savings and retirement savings, systematic investing in passive income streams, and living frugally in a manner that is right for you.
The Return on Happiness for two purchase decisions
On a daily basis, we face decisions about how to best use our limited time and money. Limited time is one aspect all of us have in common, regardless of how much earned or saved. Here, we’ll review two purchase decisions: (1) buying a used motorcycle, and (2) purchasing the one-time service of a house cleaning service. I realize that these are quite different purchase decisions! Let’s see look at the ROH of each.
How do these decisions rate on the ROH scoring matrix?
- (0 to .9) Should consider skipping this purchase
- (1 to 4.9) Is this really worth the time you had to work for this purchase? If so, go for it.
- (5 to 9.9) The cost of this decision is not much of a factor. You have permission to proceed!
- (10 to infinity) This is the elusive bliss, enlightenment, or heaven—do it now!
“The best way to pay for a lovely moment is to enjoy it.” – Richard David Bach
We have a “Yes” to both choices. However, the results for the house cleaning service indicate a clear winner. This is due to its lower cost and relatively high hours of enjoyment. Of course your actual results may vary! Please feel free to try this at home and poke holes in the logic.
A possible challenge with this calculation is how to calculate an hourly rate if you don’t work. For example, perhaps you have a net worth of $3 million. You could certainly afford either one of these costs. I would recommend that you determine a rate per hour by taking your total annual budget and dividing it by 2,080 (52 weeks x 40 hours a week) to arrive at a number for comparison purposes.
Conclusions and factors that leverage your Return on Happiness
Is it possible to measure emotional satisfaction with a formula? Maybe it is for some, yet not for others.
When you create a formula for ROH that has many variables, some of them subjective, the results can vary tremendously. For those who earn high net hourly rates, it is, of course, easier to purchase an item than it might be for someone who makes less money. The frugal-minded folk—those who find the same item or experience at a 20% to 50% discount—will make their dollars go farther. They can accomplish the same goal without the need for higher annual income, putting them on par with a higher earner.
Your enjoyment level of the choice has a big impact to the result.
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This is my first attempt at quantifying happiness for purchase decisions. It is a work in progress that will evolve, and your feedback will help that process.
Is it possible to quantify a Return on Happiness? Do you have some recommendations to improve the formula?
Photo copyright : anatols