Why Opportunity Cost Should Matter to You
“I’ve got a buddy that has a $1 Million couch”
I turned to face my VP trying to figure out why my third-line leader is talking to me about couches and how it's tied to my job.
It wasn't. Turns out, he’s also a Personal Finance nerd :)
He went on to tell me that many years ago, his friend was updating his living room.
In order to pay for the specific $6,000 couch they wanted, he needed to sell some stock in the company he worked for.
That company was a technology company that took off like a rocket.
That $6,000 in stock today would be worth over $1,000,000.
“Every time he sits on it, he’s reminded he’s sitting on $1,000,000.
No couch is that comfortable.”
Many of you reading this will reach positions where you ‘can afford’ the majority of things you could want.
You don’t need to be worried about the cost.
You do need to be worried about the opportunity cost.
What is Opportunity Cost and how does it affect you? Keep reading.
Opportunity Cost is what you don’t choose after making a decision.
In personal finance it means money spent/saved in one place can’t be spent/saved anywhere else.
An example:
You go to a car dealer and are deciding between two cars. One is $35,000 and the other is $25,000. You can ‘afford’ both.
But what’s the opportunity cost of that $10,000?
For some, that $10,000 will get you the car you’ve been dreaming about since childhood. Get the car.
But what if, instead, that $10,000 gets you your dream vacation?
What if it would pay off your student loans?
Only you can answer those questions but at least ask yourself the questions.
Or what about rent?
Your lease is coming up.
You’ve been spending $1,500 per month but could afford $2,000 per month.
Is the upgrade worth the $500/month for you? It could be.
But, what if you invested it? $500/ month invested for 10 years is $85,000.
That’s a meaningful home down-payment (or some baller vacations).
Again, only you can answer the questions, but, at a minimum, ask them.
No one else is looking out for your opportunity cost.
Car and Real Estate sellers are incentivized to sell you as much as possible without you defaulting on your payments.
Your financial goals are not in their calculations.
Personal finance is… personal. After you've passed the baseline of setting aside for emergencies, investing for retirement, and getting out of debt - you can go down a lot of paths.
In November of 2022, my wife and I moved out of our apartment and tripled our rent to move into a house.
Tripled
I’m VERY aware what that additional money would be worth today had I put it in the S&P 500.
But as you can see from this picture at our annual backyard Christmas concert... Worth. Every. Penny.
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Playing a concert on our back porch is one of the many reasons we splurge on the house. We did the math and are fine with it. Use the tables below to do your math. |
Here are two tables to help you calculate YOUR Opportunity Costs
Debating a one-time purchase? Use Table 1.
Debating a changed monthly payment? Use Table 2.
One Dollar Today Compounds to:
One Dollar Per Month Compounds to:
So that $10,000 car difference would be $21,500 in 10 years, $100,000 in 30.
No financial decision is ever perfect. But understanding opportunity cost helps you make choices with more confidence and intention.
Many never get the chance to weigh trade-offs. If you do, take advantage of it!
