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Are You Considering the Opportunity Costs?
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The following post is by MPFJ staff writer, Kelly Gurnett. Kelly runs the blog, Cordelia Calls It Quits, where she documents her attempts to rid her life of the things that don’t matter and focus more on the things that do. You can also follow her on Twitter and Facebook.
Of all the things we consider when making a financial decision, there is one factor we often overlook: the opportunity cost. Yet, it’s this factor that most greatly affects the overall course of our lives.
Say you’re planning on getting a new car. The things you might take into account when debating this expense are:
- Whether to lease or purchase.
- Whether to buy new or used.
- Which brand and model best suits your needs.
- Which car is the best value for the price.
- What dealerships are currently running sales.
These are all immediate, value-based considerations: What will get you the best product, for the best price, to meet your current needs? But, the thing most of us don’t consider is: What will I be forfeiting, or trading off, to make this purchase? What opportunities am I denying myself, right now or in the future, by making this decision?
It’s this disconnect from our choices and their consequences that gets many of us in to financial holes.
It Made More Sense When We Were Kids
When you’re a kid, holding your $10 of saved-up allowance money and standing in front of the shelves at the toy store, it’s all about opportunity cost.
We can use our $10 to buy a handful of cheap little toys, or one bigger, cooler toy. We can buy Toy A or Toy B. All we have is the money in our hand, and whatever we decide to buy with it, we’re making the choice that is the toy we want, above all others. We know that we’re giving up having those other toys in order to have this one.
We can use our $10 to buy a handful of cheap little toys, or one bigger, cooler toy. We can buy Toy A or Toy B. All we have is the money in our hand, and whatever we decide to buy with it, we’re making the choice that is the toy we want, above all others. We know that we’re giving up having those other toys in order to have this one.
It gets muddier when you grow up. Loans and credit cards and payments that stretch out over decades make all of our financial decisions seem much less concrete. We can buy all sorts of things without having to think about the trade offs, because the purchases are spread out over long, abstract periods, making the concrete amount of money we’re ultimately spending feel less immediate.
We can buy a house, two cars, take yearly vacations, and we don’t think of these expenses in terms of choosing A over B. We think of them in terms of how much we can afford to pay out over X number of months.
But, this thinking distracts us from what we’re really doing: locking ourselves into years of payments that could wind up costing us some very real, and very dear, sacrifices down the line. Every time we make a purchase, we’re (even if unconsciously) choosing that we won’t be able to have other things.
And the opportunity costs aren’t just other things we could be buying—they’re also the standard of living we’re setting ourselves up for.
A Real-Life Example (Mine)
When I was fresh out of college, making my first full-time paycheck and with credit card offers flooding my mailbox, I jumped straight into the consumer-driven lifestyle. I bought a new car. I bought a new, grownup wardrobe. I bought brand-new, trendy furniture for my tiny basement apartment. I went out all the time. I didn’t deny myself a concert, a better computer, or even a caramel macchiato if I wanted it.
Why should I? I had the money to keep up with my payments. That was all that really mattered, right?
Wrong. Thirteen years after I graduated college, I am now less than a year away from making my final payment in the debt management plan I’ve been working through for the past 4 years—all to pay off the debt I racked up when I was young and incredibly careless. In my 13 years of dealing with the opportunity costs of the bad decisions I made, here is what I’ve learned I was trading off, without realizing it:
- The ability to work at a job I cared for, because the job I hate is the only one that’s been able to let me keep up with my bills.
- A savings account/retirement fund/emergency fund. I recently read an article on how much savings you should have built up by each age in order to enjoy a fairly comfortable retirement. I’m barely 1/3 of the way towards what I should have had built up at 20, not at 31 where I am now.
- Peace of mind. Every time someone in my house gets sick…every time our cars need repairs…every time something breaks in our house, it throws me into a panic because I’m already stretched thin meeting our monthly expenses. There is no margin for error. There is no room for the unexpected.
- Stress. Because our budget is so tight, and I’m so terrified of getting into another bad situation, every financial decision I find myself faced with—whether it’s buying one brand of toilet paper over another or wondering when we can afford to fix a leaky faucet—is a major source of stress. I am frugal, first and foremost, out of a sense of fear. I hope that once my debts are paid off, I can learn to have a healthier relationship with money, but right now, it is a very broken, very tense relationship.
All this could have been avoided if I’d realized, way back then, that my spending decisions weren’t made in a bubble—they had very real, and long-lasting, consequences for everything I could buy and do and be for the next 13+ years.
Believe me, it’s a lesson I know now, and won’t ever forget.
How about you all? Do you consider the opportunity costs of your choices? What would you do differently if you did?
***Photo courtesy of http://www.flickr.com/photos/59937401@N07/5930043516/
About the Author Jacob A Irwin
Hi folks! My name is Jacob. I am the owner and operator of My Personal Finance Journey. I started this blog in January of 2010 and have enjoyed the journey ever since. Since finishing up graduate school in Virginia in 2014, I have been working in biopharmaceutical development in Colorado. You can read more about me and this site here. Please contact me if you have any questions!
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I guess when it comes down to it, everything is about trade-offs – money now and time later, for example.
Opportunity cost is something I'd like to drill into my fiance's head – he's more of an instant gratification guy so luckily he has me to keep things under control. And he is making progress, slowly…
My recent post In which I show my princess colours
That also taps into the “real hourly wage” topic I'll be getting into in a future post! Not only are you spending X dollars of your money, but you also need to spend X hours of your life earning that money. Put into that perspective (how many hours of my life is this item worth?), purchase decisions can become MUCH easier to make!
I went through this process when considering a “promotion” or out of classroom assignment. The increased income meant more hours and commuting. Instead I opted for working 4.5 hours and a 12 minute commute. I am fortunate that I can choose a job based on what I enjoy versus just the money.
My recent post Happy Holidays
I consider opportunity cost most of the time, thinking about whether an extra purchase is worth X hours of my work. Like Krantcents, I value freedom a lot so most of the time, I would rather not buy anything non essential.
You are definitely very lucky to have that freedom. The factor of commute time (and costs) is actually something I plan to explore in an upcoming post on how to determine what your “real” hourly wage was. I'm happy for you that you were able to make a decision that made you happiest!