Nima Abu Wardeh says you could secure your financial future by weighing up the opportunity cost of every purchase
Don't get sucked into unnecessary spending - think about the opportunity cost involved
If you took part in last week’s shopocalypse, this comes too late for you – sorry. It’s hard not to get sucked into unnecessary spend with all the frenzy and reported savings to be had. Black, or white in this part of the world, Friday, then Cyber Monday, they’re sold to us as the opportunity to get more for less.
Let’s stay with this word – opportunity. It always comes at a cost. You take one path, one opportunity, over another. Economics Professor Russel Roberts came up with a killer, simple, way of defining the term ‘opportunity cost’: It’s what you have to give up to get something.
We each do this every minute of every day. We give up time in exchange for paid work. Give up earnings on a lump sum and use it as a deposit for a home. The lump sum might appreciate, and you go on to sell at a profit, but it might not. It’s OK if you take this on board, and decide your priority is living in a home you love.
You sink more money into it, with fancy things and gizmos, because you decide it gives you daily pleasure, and don’t care about what else that money could do for you.
You arrived at the right decision for you, having taken into account the opportunity cost of doing it. You’ve taken on board what you’re giving up in return: a huge amount of money that could be accumulating gains if invested or deposited in certain products.
Someone I know thought of buying a new home, but then worked out it would cost him another 10 years of life - setting off to work at just gone 5am for a packed, stressful daily commute - and decided against it. The opportunity cost in the form of stress, time at work and being away from his family, was not worth the nicer home. Instead, he bought into a dry-cleaning business with the money he would have put towards the bigger place. He is his own boss, and has made the right decision for him.
The measure of ‘worth’ is not always monetary.
However, when you exchange money for something you don’t need, or don't get any ‘worth’ from, you give up future money for nothing. Giving this 'lost' cash a monetary future worth is an important thing to do. It helps you understand the opportunity cost of what that cash could do for you – for the rest of your life.
When you exchange money for something you don’t need, or don't get any ‘worth’ from, you give up future money – for nothing.
You lose out on the opportunity cost of what that cash could do for you – for the rest of your life.
Opportunity cost is not the same as out of pocket cost, it’s not only about the amount you spent.
It’s the income you could have earned from the money you used to own; income that could be generated for as long as you leave it alone - had you invested it.
Here’s our thought for today: think about everything you buy as a long-term event, not a short-term fix - a long-term investment over a short-term spend.
I like to think in terms of 10 years - maybe it’s my age and where I am in life, but I can remember a lot of things that happened 10 years ago. Decisions I made, and their impact. So I’m picking a 10-year horizon as my measure. Now let’s find out what unnecessary spend today could potentially give us over a 10-year period, assuming it’s invested and left alone.
In the US, the average spend per shopper this Black Friday weekend was US$967.13 – according to the National Retail Federation.
Let’s take this $967.13 and pretend it wasn’t spent, but locked up for 10 years with a 5 per cent return per annum. According to various online opportunity cost calculators (I chose calculators.org – I like the way they say: "Enter the dollar amount of an unnecessary, non-investment type expenditure you are contemplating".) that would have given back $625.74 in interest.
Which makes the real cost of whatever was bought $1,592.87.
Now make that 10 per cent over 10 years. Why? Because the US stock market returned an average of nearly 10 per cent over the long run. The $967.13 outlay becomes $2,618.06.
Now figure out how much money you’ve spent on stuff that you don’t need – over the past month, year, 10 years. Go online and punch in the numbers. Now imagine you had that money sitting in an account in your name. Was the stuff you bought worth not having that cash?
Sometimes it is. The point is: think things through. Including what you’re giving up to get something. You still want to go ahead? Then great, you’re on your right path. If you decide it’s not worth the spend, take that amount and add it to your investment pot.
When you buy something, work through what you’re giving up.
Nima Abu Wardeh is a broadcast journalist, columnist and blogger. Share her journey on finding-nima.com