Everything has a price. What we do, what we don’t do, what we buy, how we live, where we live. Even the miniscule has great impact on our lives now, and in the future. Every choice we make comes with a cost. But at what cost? Cost is here and now but also in the future. Most of the time we think of cost as a dollar figure. Cost also has deeper, less tangible connotation. We may pay a monetary cost, but in everything we pay an opportunity cost.
Something that we tend to forget about when spending our hard earned money is that how we choose to spend or not spend has an often hidden cost. Opportunity cost. I would define cost as the sum of our actions or inaction. It is the consequence of our choices, the sacrifice we have to give of giving up something else in order to obtain something.
When we spend money, we are making a choice. The choices we can make that having money provides us are almost endless. Our choices are narrowed down and become less, the less money we have. Also, the amount of choices and the types of choices we have become less the more of our money we choose to spend now.
In order to be better with our money we need to become more aware of the choices we make and how it effects or present as well as our future. By thinking about the alternatives we are sacrificing and giving up by choosing to spend money now, will help us build a solid financial foundation and live the life we want to live.
Some examples of spending correlating with opportunity cost are thus:
- Where we live (how much our housing costs are)
- Will we buy a big house (with a big mortgage) or a small “starter house” (with a small mortgage or potentially none at all)
- Buying a new car (along with the new car payment)
- Taking that vacation we’ve been eyeing and charging it on the credit card
- Getting a college education (and coming away with student loan payments)
When we look at the big picture items that we might buy in our lives, it’s easier to see the impact they have. Our small everyday purchases can also have a big long-term impact as well though.
Getting into debt comes with it a big opportunity cost. Debt payments are non-negotiable. They come due again and again every month whether we want to pay it or not. In order to pay the payment we must have continual monthly income that exceeds or matches the payment. For most of us, that means work. Trading our time for dollars. Now that we have to go to work everyday, we are living with the decision that because we chose to buy something in the past and go into debt for it, we have to continue to pay for it now and in the future. We can no longer have as much freedom with our time.
The bank owns a portion of our time. That is why debt is a form of slavery. We have no say in whether we want to work or not. No work, no money. No money, slave owner comes to take back what is his.
A tactic that can help us better understand opportunity cost is to take money out of the equation entirely. Instead of comparing how much money something will cost us, it’s price in dollars, say a new car the costs us $500 for the monthly payment, we can compare the cost of something with another thing we will have to give up. Choosing to have a $500 car payment might mean having to forgo 2 luxury vacations a year or having to work 5 extra years before you retire. Suddenly we can see more clearly what that extra $500 a month is really worth. What other opportunities are we giving up in order to obtain something?
Another thing that has opportunity cost is what we choose to do with our time. If we decide to watch 2 hours of TV a day, we can’t also spend those same 2 hours doing yard work, or going to the library. We may be able to do those things as well but there are only so many hours in the day, which restricts our choices. Time is a finite resource. It’s the only asset that we cannot own.
Time and money are 2 things that we can choose what to do with and how to spend them. They are correlated. It is often said that time is money. But I like to think that money is time. The huge difference between time and money is that money is an infinite resource, time is not. We all will die eventually. Our time on earth will run out. That is a fact all of us understand.
Instead of focusing on how to have or get more money, we should focus on how we choose to spend our time. Life is more fulfilling when we are happy with how we choose to spend our time rather than having the choice to spend money.
Does it make us happy because we chose to buy larger house with a bigger yard and an extra bedroom and in the process got stuck having to pay a large mortgage every month, therefore requiring us to work at least 15 hours a week for the next 30 years?
Of course we could get a better job or promoted therefore not having to work as many hours to pay the same mortgage payment. But the trend is that when we do get that promotion or better paying job, we end up having to work the same hours or maybe more because we might want to buy a bigger house and thus increase the payment to match our larger income.
Maybe we would be happy being financially independent, not having to answer to anybody, and therefore being able to choose whatever we want to do with our time.
When we see the bigger picture and can sacrifice now for our future selves, we can give ourselves more opportunities in the future. When we save and invest money now, we have to pay the opportunity cost of sacrificing what we can buy now, but in turn we receive even more opportunities later, which would have otherwise been forgone.
Instead of living paycheck to paycheck now, we can choose to save and invest half of our income and in turn become financially independent in 15 or so years. When you take into account the power of investing money, current choices become more costly. The value of X amount of money now and the value of X amount of money decades in the future is pretty much no comparison. By spending $1000 now, we are giving up being able to spend $45,000 40 years from now. That is, if we would have saved and invested that $1000 in the stock market (S&P 500), which has historically returned, 10% average a year.
A huge hurdle that we must get over is the fact that to consume something now or have it now, will always be better than to resist and not have what we want now like saving for an abstract future. The immediate is much more salient. Things in the future are less tangible and harder to connect with and therefore they have less of an impact on our decisions versus having something now.
To better put our spending in perspective we can think about our purchases and or choices in terms of life instead of in terms of money.
We need to seriously think before we spend. In order to live our best lives and be happy financially, we must:
- Define our ideal life
- Understand what makes us happy and what provides value for us
- Weigh our spending (time and money) with what opportunities we are forgoing (What is the opportunity cost.)
- Be intentional and align our spending with our true values
Finally, opportunity costs is closely associated with our risk tolerance. Coincidentally, the more calculated risks we are willing to take, the better our chances of success and opportunities we create. Perhaps spending all of our money now and living for the moment is the biggest risk (We may live to be 100). Perhaps being frugal and saving for the future is the bigger risk (we may die tomorrow) – We may not know how much time on earth we have but there is a far bigger chance we live a long life. That’s why insurance companies are able to sell life insurance with a million dollar pay out with a small monthly fee to the insured. They’re betting big on you living.
You should too. Imagine you woke up from a devastating coma where you were not given a good chance to make it. How would you live your life with a second chance? Imagine you found out with certainty you were going to live to 100. Will you save for you future self? In the words of Getty Lee of Rush, “If you choose not to decide you still have made a choice.” All of our choices have a price.