|Gary Foreman is a former Certified Financial Planner (CFP) who currently writes
about family finances and edits
The Dollar Stretcher website
http://www.stretcher.com. You'll find hundreds of FREE
articles to stretch your day and your budget!
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.
website 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
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.