Consider Your Opportunity Costs!
Not grasping this concept will set in stone, a lifetime of financial struggle, for you and your loved ones.
Especially because not considering opportunity costs has a cumulative negative effect on your finances.
The way that people usually think, when it comes to spending money, is strictly from an accounting standpoint. Not an opportunity cost standpoint. In accounting, costs are the monetary value of spending money: if something costs $10, and you buy it. It cost you $10.
But with opportunity cost, it’s the opportunity you’ve decided to give up, by spending the money right now, on something, versus on something else. In other words, opportunity cost isn’t what you get, but what you gave up.
Here’s an example
Let’s say you make $10 an hour. You decide to go to the movies with some friends, so you miss 4 hours of work. The cost then, in this scenario, isn’t just the $10 movie ticket. The cost is $10 for the ticket PLUS the additional $10 per hour you gave up in order to go to the movies. So a total of $50. Since you missed 4 hours of work.
Even if you went on your free time, 4 hours is still 4 hours. Within that 4 hour time frame, you might’ve been able to squeeze in another shift at work. Or you could’ve as easily hopped in your car and made between $60 – $100+ driving for Lyft.
So this is a direct and instantaneous net negative result on your finances. But are there any other negative future implications?
You have to typically make more than $1 to end up with $1
A dollar saved, is worth a lot more than a dollar spent. Why? Because of taxes. Here in the US, you need to make like a buck 20 or a buck 30 in order to end up with $1 in your pocket. It’s a lot more in other countries because the US has pretty favorable tax laws. In many countries they take half or more of your money! So in other words, you have to make more than a buck to end up with a buck.
Second, a dollar saved is worth astronomically more than a dollar spent today
Because of the opportunity cost of spending that dollar today versus saving and investing it for it to become more than a dollar further down the road. So in other words, when you spend a buck, you’re spending what would’ve been a lot more than a buck further down the road.
To give you some perspective
Let’s assume 7% annual returns for the total US stock market, over a lifetime of working (let’s say a 45 year career). Every dollar you spend is roughly $20 of future money. So in this example, $10 spent today could have been $200 future dollars. $100 spent today could have potentially been $2000 future dollars!
Now, the take-away from this isn’t to guilt you, or to tell you you can never ever spend the money that you’ve worked hard for. Or to even suggest that you should get into a habit of some form of paralysis by analysis every time you’re buying a $2 cup of coffee. It’s more for you to realize the value of your money and your time, from an opportunity cost standpoint. And not just an accounting standpoint.
I’ll end on this note:
There’s a relatively high chance, especially if you’re living in the US, you’re most likely reading this blog on a $800 smartphone or a $2000 computer. Which in our example I used earlier, is potentially equivalent to tens of thousands of future dollars!
You’re well ahead of the curve if you already knew that. And if you didn’t, that’s fine too, since you know now; and maybe it’ll give you some pause the next time you’re tempted to buy something. Especially when it comes to a big ticket item.
Care to share a time when you spent too much and it ended up exacting a heavy toll from an opportunity cost standpoint? What about a time you made a good decision, and how did that decision financially benefit you later down the road?