I have a confession. I can’t remember 90% of the academic material I learned at University!
The good news is that the 10% of what I did retain has served me well.
One concept from my economics curriculum that stuck with me is the idea of OPPORTUNITY COST.
Opportunity Cost Definition
Opportunity Cost is defined as a benefit that a person could have received, but gave up, to take another course of action.
This is just a fancy way of saying that choices leave you with trade-offs!
These trade-offs, or opportunity costs, are mutually exclusive meaning if you choose one, then you can’t do the other.
Why is this concept of Opportunity Cost so important? Well, it affects nearly every area of our lives.
How you spend your time, manage your capital, or who you interact with all shape the quality of your life and ultimately your destiny.
So, it’s incredibly important to be able to make healthy decisions and examining your opportunity costs can help!
Opportunity Cost Examples
When I was considering an early retirement 3 years ago, I had to make a choice. I couldn’t do both of these simultaneously.
Choice 1: Continue working and earn a healthy 6-figure salary plus benefits
Choice 2: Retire early and become a stay-at-home Dad
Both of these choices were good, but which was better? I decided to evaluate them from an opportunity cost standpoint.
Opportunity Cost of Choice 1: Miss out on my children’s prime years of development
Opportunity Cost of Choice 2: Forgo my prime working years, earning potential, and slow our net worth velocity
In the beginning, I closely considered Choice 1. I thought earning more money would eventually lead to more freedom and choice later on with my family. But, that thought was flawed. You see, you can always gain more money at a later point in time, but you can never gain back the time you’ve lost.
So, I realized that Choice 2 was more aligned with my goal of building a closely connected family. You see I grew up in a broken family for a good chunk of my childhood, so I value a strong family presence for my own children.
Finally, I realized that kids are more likely to want to hang out with you when they’re little, so I might as well get in the prime time with them now. I can always go back to work when they are older and more independent.
Here’s another simple example. Should you attend University, or not?
Choice 1: Attend University
Choice 2: Do NOT attend University
Opportunity Cost: Not being able to work and produce full-time income for 4 years
Opportunity Cost: Loss of increased lifetime earnings associated with having a college degree
Neither choice is inherently right or wrong. But, once we add in some context, like your personal goals, then there is probably a choice that is more aligned with the attainment of your goal.
For the sake of argument, let’s say that you are more interested in building a larger income for yourself over the course of your career. Well, then you would probably want to make the investment into attending University to increase your probability of finding a higher paying job.
Evaluate Your Goals and Outcome
How do you know where you are going? Do your current choices support this?
Since we’re talking about personal finances here, where are you currently?
– Consider these self-evaluation questions –
What’s the opportunity cost for NOT managing your own finances?
Opportunity cost: $Unknown! How can you measure something if you don’t know where you’re at? If you need some help figuring this out, check out my prior post How to Budget Like a Badass.
What’s the opportunity cost of 5 x $6 lattes a week?
Opportunity cost: $30/week or $120/month invested into an index fund earning 8% annually over 20 years = $66,498!
Now, I’m not typically one to suggest you get rid of a daily expense like coffee, I’d rather you figure out a way to make more income… BUT! If you aren’t making headway with your financial goals, you should at least be aware of the costs of your actions.
Perhaps you scale back some, or other similar cash flow habits (going to watch movies, going out to eat, going to get a manicure… it all adds up!)?
What’s the opportunity cost of not asking for a raise?
Opportunity cost: $10,000+
This will depend on how much your base salary is, but it could feasibly translate to a 5-figure increase. The problem is that we sometimes think the “system” should take care of us. But, what if your company doesn’t do annual reviews? What if you’ve taken on more responsibility and are providing more value to the company? ASK!
What’s the opportunity cost of working in a job you hate?
Opportunity cost: priceless
This one doesn’t have a price tag because working a job you hate is just asinine! Wake up.
There are always other opportunities out there. If you don’t like what you’re doing, change it!
What’s the opportunity cost of working 80+ hours/week?
Opportunity cost: Time for yourself/friends/family
Now, this may be a fine and good decision in the short-term, but don’t fall into the long-term trap – the workaholic’s rat race! Consider the opportunity cost of time lost with loved ones and friends. Chances are you won’t be able to be as present as you’d like to be with them.
What’s the opportunity cost of watching TV for 15 hours/week?
Opportunity cost: 15 hrs/wk = 60 hrs/mo = 720 hrs/yr = 30 days or 1 month of your life per year!!
I’m not suggesting that you stop watching TV, but maybe not so much! Moderation is the key. Imagine what you could do with a whole extra month in a year!
You could learn a whole new language, write a book, master a hobby, start a new business, etc…
What’s the opportunity cost of NOT starting that side business you’ve always wanted to do?
Opportunity cost: $0 – $1,000,000+
Is it entirely possible that you could start-up a business and fail? You bet! If you don’t start one, however, you’re guaranteed to never succeed in business. The opportunity cost = instant failure and regret!
Starting a business is not only exhilarating, but it helps to keep your mind active and is a ton of fun! The rewards can be incredible too. I can’t begin to tell you how many business owners I’ve met over the years who made a small fortune because they followed a silly dream… even when they didn’t believe in themselves 100%.
Why not you?
Of course, this list goes on and on, but you get the point. It’s incredibly helpful to self-evaluate the opportunity costs in your life so you’re aware of the choices you are making every day.
Any Adjustments to Make?
So now you’re at least aware of where you’re at. Are you okay with it?
I say, don’t become a victim to habit or monotony. If you’re not acting in a way that supports your future goals… ADJUST.
Make sure you understand what you’re giving up so that you can appreciate your decision.
Make a conscious decision to change your current trajectory and DO IT. I assure you if you have a big enough WHY you will find a way.
Remember, it all starts with the little actions. Change doesn’t need to be difficult. It only needs to happen.
So what do you do if you don’t know the opportunity cost? It’s okay!
Know yourself and your prior outcomes. Are you looking for different results?
Don’t let analysis paralysis trip you up. You can’t analyze everything and try to optimize your life to the max, you’ll go crazy!
If you think you can’t do something… then perhaps you must do it then!
Don’t settle and wallow in the comfort of habits. The ultimate opportunity cost could be the very freedom you’ve been looking for.
Readers, have you ever evaluated your opportunity costs (trade-offs) in life? If you haven’t will you?