by Gary Foreman
From "Best" to "Good Enough"
When Opportunity Knocks
Sometimes it's helpful to take a concept out of its 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 the 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.
Would you like to
pay off your credit cards
in less time
for less money?
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 and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and he's a regular contributor to CreditCards.com. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.
Take the Next Step
- Have you tried to budget and failed? Your odds of success go up dramatically with Simple Money Management from Quicken It's so easy, you'll wish you had been using it for years!
- Do you struggle to get ahead financially? Then you'll want to subscribe to our free weekly Surviving Tough Times newsletter. Each issue of this html newsletter features great ways to help you stretch your dollars and make the most of your resources.
Share your thoughts about this article with the editor
Trending on TDS
- Talking to aging parents about finances Expert Interview
- How are relationships affected by money?
- The emotions behind buying stuff
- Should you create a trust?
- Are hidden fees stealing your retirement?
- How do I make my spouse a tightwad?
- Tips for radical cost cutting
- Control your spending by using cash
- How investing style changes over your lifetime
- 5 poor ways to save (and how to do better)
- What to do if your credit card rate goes up
- 40-something and way behind on saving for retirement
- 5 big bills you can cut fast
- Money-saving secrets of the rich and frugal
- Reduce your debt with this free debt course by The Dollar Stretcher
- Reduce your debt payoff time
- Find a better credit card rate
- Get better savings & MMA rates