I first heard the term “opportunity cost” from Dave Ramsey when I took Financial Peace University. According to Investopedia, it is defined as the benefits you could have received by taking an alternative action.
For example, you could play the lottery every payday, but you’d lose the opportunity to invest that money.
Or, you could buy produce that is only organic, but you’d lose the opportunity to buy more chocolate.
Here are two great, slightly embarrassing, examples from my own life.
My son turned 1. He was mostly happy about this. And mostly clueless about every party ritual we subjected him to.
Still, Dontae and I cashed in our piggy bank, deciding to use it for presents.
Our nephew also turned 1, so the presents were for both of the “cousin twins”. Our coins added up to roughly $50.
There was something special about knowing how much time was spent saving those coins. And that each present was something the boys would really enjoy.
Now for the embarrassing part…
The same day I bought presents for the boys, I completely blew $50 on a cake. I mean, for all this talk of frugality and what not, I really tanked.
My in-laws were in town very briefly, so I skipped the homemade route and bought cakes for the party. Little smash cakes for each boy. A sheet cake for the adults.
So I guessed at what size to get, deciding on a half sheet.
It wasn’t until I was in the check out lane that I saw the price tag. $51.99! OUCH. I thought for sure it would be half that price. At MOST. Gulp.
That cake could have fed a party 3x our size. The birthday boys didn’t even know it existed. Yes, we can give it away and freeze it, but the whole experience made me feel sick knowing how wasteful it was.
So those are two very recent, very REAL examples of opportunity cost. You can spend $50 on some meaningful, hand-selected gifts. Or you can spend $50 buying too much cake.
Opportunity Cost isn’t always good vs. bad.
It’s not always black or white, win or lose, right or wrong. It’s just a trade off that needs to be monitored, otherwise you’ll miss a lot of great opportunities.
You could spend $800 on Christmas gifts, but you would lose the opportunity to do extra traveling that year.
You could buy a new car instead of used, but you would lose the opportunity to be debt-free sooner.
You could spend your monthly fun money on some new shoes, but you would lose the opportunity to get a collector’s edition of an Amazing Spider-Man comic book.
I believe in my grandmother’s golden rule: S.A.T. Stop And Think. Before your next purchase, whether it’s a gourmet coffee, pre-sale tickets to see Star Wars VII (they don’t exist, sadly), or a house, ask yourself these 6 questions:
- What opportunities am I trading for this? Will this help me spend more time with my loved ones? Will it further my career? Will it benefit anyone besides me? If not, am I OK with that?
- Is this a need or a want? Wants are acceptable, but what needs am I giving up by pursuing this want?
- Am I giving up what I want in the future for what I want right now? What are my long-term financial goals? If I said yes to this now, how would it hinder those goals?
- Do I have the money for this? Am I giving up the opportunity to stay ahead on my payments? To live comfortably? Is this purchase worth risking that?
- What is one free alternative to this? Is the snack at that gas station really necessary, or can I start bringing snacks from home? Do I use my gym membership enough to justify the cost, or can I work out at home?
- Does my spouse/accountability partner agree with me making this purchase? Does someone I trust feel unified with me in this decision? When was the last time I asked them?
Join the Discussion: What opportunity costs have come up in your life in the last month? How did you weigh your decision?
Photo Credit: Modnar (MorgueFile)