Today on the blog is a guest post by Maggie over at Northern Expenditure who blogs about their journey to early retirement. Be sure to check it out!
As Nicola gets some much needed rest, I’m honored she is allowing me to be a guest on The Frugal Cottage. Nicola’s journey towards early retirement is very similar to ours. We’re on the slow and steady track that will take several years. We live in Alaska, which means that we get to spend our weekends hiking glaciers and watching beluga whales, but it also means things cost more money. My husband doesn’t have a high-paying job, but it allows him to be home a lot with us now, and that’s not something we’re willing to trade for an earlier early retirement date. I work primarily as a stay-at-home-mom of three, but I also work part-time from home as a behavioral economics researcher. This means I do research about money every day.
The Quality-Adjusted Life Year
In the healthcare sphere, research is important in determining if a treatment is effective. If it does actually work, it’s important to figure out the cost of that treatment and if the cost is worth the result. This calculation used to simply involve years of life. A study would determine how many years your life was extended by that treatment. In the late 1960s/early 1970s, healthcare researchers realized the measurement was not ideal because if the treatment was able to extend life five years, but those five years were spent unresponsive and bed-ridden, maybe the treatment wasn’t worth it after all. Thus the “quality-adjusted life year” was born (or QALY for short). The QALY for a procedure is calculated on a scale from 0 (dead) to 1 (one year of full health). The QALY calculates the amount of time (pro-rated for health) a health intervention adds to the patient’s life. Our earlier example of five years unresponsive and bed-ridden might only earn .2 life years (although sometimes QALY calculations can be negative which indicates “worse than dead”).
QALY for Retirement
The personal finance community is fabulous at making very strict calculations about what everyone should be doing. Of course, everyone does not max out their retirement funds at age 20. The simple reason is because they miscalculate the QALY gained from not contributing. The most common excuses are “I can’t afford it” or “I’d rather enjoy life now, while I’m young.” Both of these excuses indicate prioritizing other things. It’s important to be honest with yourself, but you also need to make an honest calculation of the QALY of the financial treatment (which, in this case, is contributing to retirement accounts). For example, in our lives, we’ve calculated that my husband could probably retire a bit earlier if he worked for a different company, but we would give up a significant amount of quality life now (he gets a lot of time off). For us, we’ve made that calculation and it’s worth the trade for us because we can spend that time together while the kids are still young. For some people, spending the money now instead of investing would give them some quality of life (unless they go into consumer debt, which I would count as 0 QALY), but they are trading several full years of retirement life (at full financial health, or 1 QALY) by not contributing.
QALY in Mortgage Pay-off
Discussing the concept of quality-adjusted life years in regards to mortgage payments also helps enrich the discussion. If the interest rate is low on the mortgage, many will argue that it makes no financial sense to pay off the mortgage early. For some people, QALY will not change this decision, but for others, factoring in QALY will equate to paying the mortgage off early. Financially, it may be better to keep the mortgage for the full term and invest the money instead, but my quality of life is diminished because of the debt. The market goes up and down, but paying off the mortgage provides me a promised return of that much less money I’ll have to pay in the future. If everything goes awry and I’ve paid off my mortgage, my quality of life will be much higher than if I still have that mortgage looming. For us, these factors have led us to put more toward our mortgage each month, but also invest at the same time instead of throwing it all at the mortgage because we don’t want to miss out on all of the compound interest available.
What financial decisions do you make that factor in quality-adjusted life years? How would adding QALY to your calculations change your decisions?