Making the consideration of opportunity costs an instinctive, automatic habit is one of the THE best ways to start making better financial decisions. However, first we have to define the term. What is an opportunity cost?
An opportunity cost is the cost of the best alternative foregone.
How does this relate to money? This means that every dollar you spend has an opportunity cost in that you could have spent that dollar somewhere else. Once I started consciously thinking about the opportunity costs of my money, I finally got the mental fortitude to cut spending and start living below my means.
Let me explain. I have written several blog posts on how to save money on small things like haircuts, cable and gym memberships. Some of my friends have told me that they can afford to go to a salon, pay for a thousand channels, and work out at a gym. Some of them even have zero credit card debt and an emergency fund. That’s great, but just because you can afford those things, doesn’t mean you should. You could be missing out on even better ways to spend your hard-earned cash.
When you start to calculate the opportunity costs of the dollars you spend on the little things, they add up quickly. Many of us have the good fortune to be able to spend $50/month on haircuts. That’s great. But ask yourself: what else could I be spending that $50/month on? Perhaps I could enroll in that training program I’ve always wanted to attend that will boost my earning potential by $10,000/year. That’s a 600% return on your investment.
Or perhaps you don’t want to invest the money, but you’ve been saving up for that sweet Chevy Camaro from the Transformer movies.
Using my tips on how to save money on the little things could free enough cash flow to buy the Camaro. In the case, the opportunity costs of the dollars you were spending is a brand spankin’ new, engine roaring sports car.
We all subjectively value different things. I’m not here to tell you what to buy. Some of us are miserly savers who get a kick out of optimizing our credit score, and some of us just want to be able to afford the new iPhone 4S so we can talk to Siri. I’m here to help you learn The Art of Money so you have the ability to choose.
The big takeaway from this blog post is that you should be looking at all your expenditures and asking, “what’s the alternative?”
If you can find a better way to spend your dollars, you will be able to prioritize your spending, saving and investing activities and more rapidly achieve your money goals.
What spending, saving or investing goals are you foregoing because of wasteful spending? I’d love to hear from you in the comments.
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