How do you decide whether you can really afford a vacation? I’m talking with a friend about taking a trip from New York City to Japan in the fall, which will probably set me back at least $2,000. On one hand, I can’t really afford it, in the sense that I could put that money toward building up a six-month emergency account or paying down student loans or otherwise being a responsible adult. On the other hand, I have the money in my bank account—so technically I can afford it, and you only live once. Is there a certain percentage of your income that you’d recommend spending on vacation (the same way people figure out how much to spend on an engagement ring)? Or other rules of thumb you might suggest?
– Potential jet-setter
Bad news first: There is no rule of thumb for how much to spend on a vacation. Worse news for other readers: Rules of thumb about spending on an engagement ring are also ridiculous. If your goal is to optimize your happiness via spending (and it should be!) then rules of thumb like this are very unlikely to lead you to the right answer.
The better news is that there is a structured way to think about these choices, albeit one which is a bit more involved than the two-months-of-salary rule.
The central question to consider: What is the value to the alternative use of your $2000, if you do not take the vacation? You need to trade off the happiness you get from the vacation to the anticipated happiness from other uses. If the vacation is the best way to use the money to maximize your happiness, then go ahead and book that flight.
The easy part of this is thinking about how happy the vacation will make you. You presumably have some idea about what you’ll be doing in Japan—say, eat sushi, stay overnight in a Buddhist temple, and pay a visit to Cat Island?—and how much you’ll enjoy those activities. You can also think about how much you’ll value the anticipation of the trip, and the memories you make there. These are all things that contribute to the value of the vacation.
Then it’s time to compare the value you’ll get out of the vacation to other uses of the money, and how much those are worth.
You mention two specific ideas—building up your emergency fund and paying down student loans. Both of these deliver future happiness, but you can still evaluate them.
In the case of student loans, if you pay them down faster now, you’ll have more money later. And because of the nature of the loan (specifically, because you pay interest on it) you’ll have more than $2,000 extra dollars later if you pay $2,000 now. The question is: Do you value this money in the future more, or less, than you value money now? If you expect to have more expenses in the future (kids, buying a house, etc.) you may value money in the future more. On the other hand, if you expect to have more income in the future, you may value the marginal dollar less. The thought experiment is simple, even if coming to an answer is not: Would you rather have $2,000 now, or something like $2,500 in 10 years?
The emergency fund is a bit more difficult to think about, since now we have to introduce uncertainty on top of everything else. If you don’t find yourself facing a root canal in the near future, then it will be too bad to have missed the vacation. If you do encounter an emergency, however, you will be sorry you spent so much of your funds on a robot hotel. Think about how likely it is that you’ll face an emergency, and how much of a difference $2,000 will make. If the emergency is $100,000 worth of medical bills, the $2,000 will probably not matter in the big picture. If the emergency is a month out of work, it may matter more.
Roughly speaking, you want to think about your relative sense of security in the emergency with and without the $2,000, and the chances of this emergency. Then compare that to the happiness you expect to get from your trip. If the trip dominates, then start researching the best ramen places ASAP.
As a final note: Once you have decided to spend money on vacation, it is probably worth thinking about whether this is the best vacation. Once you free up $2,000 to spend, is Japan the place you most want to go? If not, it may make sense to take a vacation to your dream destination. You can explain to your friend the theory of optimal vacation planning while you jet off to Monaco. I’m sure she’ll understand.
Emily Oster is an associate professor of economics at Brown University and the author of “Expecting Better: Why the Conventional Pregnancy Wisdom Is Wrong — and What You Really Need to Know.
Got an everyday problem that could use an economist’s point of view? Send Emily your questions at email@example.com.