Opportunity Cost

In saving and retiring we have to understand a concept called opportunity cost. This is the cost associated with doing one thing over another. This doesn’t only apply when financial matters are concerned but pretty much whenever a decision is made.

For instance, if I wake up one morning and decide that I really don’t want to go to work, I would evaluate the opportunity cost calling in sick. First, I would lose 8 hours of sick time, which would hinder my ability to call out sick if I were to actually catch something. So my immediate opportunity cost would be losing some sick time. Second I could evaluate my work situation and decide if missing work that day would cause any other hardships. Maybe it could cause me to miss a meeting that would put me behind on operating procedures. So, opportunity cost number 2 would be being less knowledgable due to a missed meeting.

Now we can tie this mindset into investing. In a previous post, I referenced how 1 dollar would turn into $4.32 in 20 assuming an 8% return. What this means, is that the opportunity cost of buying something with 1 dollar would be both, not receiving whatever you bought, and also not having 1 dollar. Following this, the opportunity cost of not having invested that 1 dollar would be 8% compounding every year or 3.32 cents in 20 years.

Now understanding this we can understand that by not investing, you are making an active decision to not get this money.

“But Captain CashFlow, I decided against adding the extra guac on my chipotle order, I’m all good, right? I saved my $1.95!

Well yes, you did decide to keep your $1.95 instead of spending it, but now what? What are you doing with that money? You could only be keeping yourself from losing that $1.95, or you could invest it and make that decision worth roughly 8% compound every year. Deciding to not have guac this one time could mean having $9.09 in 20 years if you just drop that into your investment portfolio.

Sure $9.09 may not be much for retirement but all you did for it was not get extra guac, once. Now think of all of the things that you don’t necessarily need. Look at what your barebones expenses could be and use a compound interest calculator to see what simple changes could end up being. What’s important to note is that by not taking action, you are already costing yourself this money.

Use this website, plugin what you could be saving annually, with a few changes that we can go in detail about later, and decide for yourself if this is worth it. For encouragement, I switched from AT&T to a new provider and am saving roughly $113 dollars per month. I multiply that by 12 for savings per year, and I have $1356. Now I plug that into the compound interest calculator for 8% and 18 years (this is my desired time until retirement) and by making this tiny switch I will be $54,845.13 closer to retirement.

See what you are really spending on some of your subscriptions, or your daily sandwich or cup of coffee.

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