Before we start I must give you a disclaimer. I have an economics degree and I currently spend my days as a professional excel jockey for a financial institution. So in other words, I like to math.
Boring….next article Egon.
I understand you may not live for this stuff and that’s cool, I guess, but you should at least get familiar with this topic as it could drastically change your life.
Understanding the impact of simple every day decisions could be the difference between being broke and becoming a millionaire. Full on mastery of this subject could allow you to retire early without needing a massive salary. Don’t get mad at the world for not being financially fit, get mad at your decisions.
Wait…what the what??
Let’s time travel all the way back to 2001 where I was a sophomore in college sitting in my Intro to Economics class. There I was, reeking of chlorine with badly damaged pool hair receiving the most valuable piece of knowledge that this fine institution handed me:
What does this mean? I always joke that one day those two words will appear in the “reasons for divorce” section of the papers my wife will serve me. But flipping through my old college textbook (Principles of Economics, Gregory Mankiw) I Came across this definition of opportunity cost:
The opportunity cost of an action is what you must give up when you make that choice.
Easy enough. Nothing is free. Even that free lunch the timeshare people offered you.
Now opportunity costs can come in both financial and non financial ways. Let’s look at both.
Non financial example
Your wife’s college roommate is having a bridal shower on a Sunday in October and you get the pleasure of coming along! You’ll get some Swedish meatballs, a glass of Chardonnay and the chance to sit in a room with a bunch of other mopey dudes you never met but it will cost you some tolls and gas to get there. Most importantly you will miss the Steelers game that afternoon. That stinks! The cost of those meatballs is drinking lousy Chardonnay and not watching the game. Ya dig?
You’ve finally decided that you want to start riding a bike. Great decision by the way! But, uh oh, here comes the internet with all its recommendations and top ten lists. “You must get this $2,500 Cervelo instead of the $1,000 Diamondback with the same components because one says “Cervelo” and the other says “Diamondback.” You surely can ride on nothing less, that’s unpossible.
So you buy the Cervelo. SMH.
Lets examine some of the (infinite) opportunity costs of that decision:
- You could have bought the Diamondback and spent that extra $1,500 to take your wife away on a vacation. A fancy new bike plus a vacation and happy wife for $2,500 is a fantastic deal. She’ll probably forget you just dropped a grand on a bike that you probably won’t ride anyway. But instead she’s just mad that you spent $2,500 of y’alls money when you could have spent less and now she didn’t get to go on vacation. If you end up actually getting into to riding she gets to sit at home while you put on lycra and ride that $2,500 of hers around town for 5 hours. Way to go broski.
- With that extra $1,500 you could have bought a GPS watch, helmet, jersey, pedals, shoes, shorts, booties, water bottles and still have money left over! Or you could have invested in a baller set of wheels making the $1,000 Diamondback even better (side note Diamondback already puts pretty nice wheels on their bikes). But nah, this says a fancier brand on it. Mctotes worth it.
- While I wholeheartedly endorse scenarios 1 & 2 were going to consistently look at what your money could have done had you saved/invested it.
Lets assume you invest that $1,500 extra you had set aside for a bike in the US stock market, which has returned ~6% since 2001, the year I learned about economics. It just sits there, like your unused bike, but rather then depreciating it compounds, over, and over, and over.
Here’s the value of that $1,500 a 1, 5, 10, 15 and 20 years:
|Cost of thing||$ 1,500|
|Value in 1 year||$ 1,590|
|Value in 5 years||$ 2,007|
|Value in 10 years||$ 2,686|
|Value in 15 years||$ 3,595|
|Value in 20 years||$ 4,811|
OK neat but you were talking about becoming a millionaire. You’re telling me I could have made $1,186 in 10 years. I can’t retire off that!
Lets apply this to every day decisions that you make. Most of my articles show you how to save a few bucks here and there and this adds up. This is how millionaires are made.
Pretend you can save 10 bucks a day which equates to about 300 a month….“Woh now. I can’t save an additional $300 a month, that’s crazy.”
Perhaps that is true for a select portion of the population. But if you’re on this website you probably have some extra cash otherwise you shouldn’t have signed up for that Ironman. Look at your monthly expenses, like really look, hard. Daily coffee and Dunkin Donuts, restaurants, booze, take out, cable, phone bills, car payments, breakfast and lunch at work, gas, tolls…you get the idea. Stop throwing your money away on stuff that doesn’t matter.
So 300 bucks a month, compounded at 6% makes you a millionaire in…48 years That’s forever, but that’s only $300 a month. $1,000 set aside each month at you hit that mark in 29.86 years.
Because you may not be a nerd I’m attaching the Opportunity Cost Machine workbook to help you with your own calculations. Its broken into 3 parts. All the green fields are inputs.
- Straight purchases – how much that money you spent on something would be worth in the future had you not spent it.
- Monthly expenditures – how much a reduction in monthly expenses (i.e. cable, power, training nutrition, etc) would add up to in the future.
- When will I be a millionaire? How long it would take for a consistent savings amount to equal a million bucks.
So before you open up that wallet at the running store take a moment and ask yourself “Do I really need to buy the $130 pair of shoes instead of the $50 pair? Are they really worth it?”