Lost Opportunities
The Dollar Stretcher
by Gary Foreman
Sometimes it's helpful to take a concept out of it's original environment
and see how it fits someplace else. Today we're going to examine an
economic theory and see how it might apply to our personal lives.
The Economist website <economist.com>
defines 'opportunity cost' as "The true cost of something is
what you give up to get it. This includes not only the money spent
in buying (or doing) the something, but also the economic benefits
that you did without because you bought (or did) that particular something
and thus can no long buy (or do) something else."
To put it simply, for everything you get, you give
up something else. That's an important concept. Let's consider an
easy example. If you spend $15 on a pair of jeans, you do not have
that money available to buy a pizza. The 'cost' of the jeans is not
only $15. It is also giving up a pizza.
Another way to look at opportunity cost is the amount
of time we give up working to buy a product. Suppose you make $12
per hour. Our tax rates are all different, but you can pretty much
expect to pay about 1/3 in Social Security and federal, state and
local income taxes. That leaves you with $8.
Let's further suppose that you go out to lunch with
co-workers every day. And a typical lunch costs you $6. Add a tip
and sales tax and that lunch brings the total to $7.20. So you give
up 54 minutes of your life every day to work just to pay for lunch.
How about a different situation. Remember that an
opportunity cost is what you give up by making another choice. For
instance, suppose that you choose to spend $100 on a credit card knowing
that you'll pay the minimum when the bill comes due. In effect you've
given up about $140 in the future to make that purchase today. That's
because finance charges will be added to the cost of your purchase.
We face opportunity costs with our time, too. I can
choose to spend an hour watching TV. But that's an hour that I won't
be talking to my wife, playing with the kids, doing home projects
or sleeping. Of course, watching TV might be the best use of that
hour. Still, it's a good idea to think about it before you spend the
hour.
Sometimes the difference between choices is surprising.
Suppose you spend $1 at break time five days a week. No big deal.
Right? But if you didn't spend that dollar every day and put it in
a bank at 3% interest, you'd have $3,000 in ten years. Or $7,100 in
20 years. Or $20,000 in 40 years. So by choosing that $1 snack each
day you've given up a new car when you retire. A good trade-off? Only
you can decide.
There's also the possibility of trading money today
for time tomorrow. For instance, you could use the money from those
work day snacks to allow you to retire 3 or 6 months earlier than
you would otherwise. Is it unusual to think of 'banking' a few minutes
each day towards an early retirement? Perhaps, but it does give you
a new perspective on spending.
But, what about credit cards? Don't they make it
possible to buy both things that we want? Yes, you can use your plastic
to do that.
But credit cards are deceptive. They lead you to
believe that you can spend more than you make. And, for a short time
that's probably true. But eventually you get to a situation where
you can only afford the minimum payment each month. Once there, you're
back where choosing to spend on one thing prevents you from buying
something else. And, you've also made the choice of paying interest
to the credit card company on the monthly balance instead of having
that money for other uses.
So how can you use opportunity costs to help you
live a happier life? By thinking of the alternatives before you spend
your time and money. Even though something looks good, if you stop
to compare, you might find something else that you'd prefer to spend
your time or money on.
Gary Foreman is a former financial planner who currently
edits The Dollar
Stretcher website <www.stretcher.com>
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