Opportunity Cost: The Ultimate Game Of “Would You Rather?”

Would you rather be a bear or hippo?

Which superpower would you rather have: Flight or Invisibility?

Now let’s try a money question:

Would you rather pay $900 a month for 5 years to drive a BMW now or instead wait 5 years while saving $800 a month in a 2% interest-bearing account to buy that same car?

Before we answer that question, let’s weigh the options. Paying $900 a month means we don’t have to wait on the car purchase, so if we need a car right away, that would likely be our selection. However, we are paying $6,000 more (or 60 months x $100 / month), which could have gone to savings or spending money. Investing $100 a month at 7% interest over 30 years would give us an extra $113k. Perhaps we throw a third option to the mix: Buy a $25,000 car instead of a $50,000 car?

By choosing the $900 a month route, we are essentially rejecting the possibility for greater wealth in the future. By choosing the $800 a month route, we are rejecting the immediate timeframe for owning a car. The price we pay for the choices we reject is known as opportunity cost. Every path we don’t choose has a cost associated with it. And while everyone has different answers, the key is to pick a choice that aligns with our needs and our vision for the future. Opportunity cost is just a big game of “Would You Rather?”

Opportunity cost is just a big game of

“Would You Rather?”

Whenever you make big financial decisions, instead of phrasing it: “Should I do this,” maybe try ” Would I rather do (this) or (that)?” This allows you to explore the alternatives. If you’re buying a place, would you rather buy a $350k condo now or save to buy a $500k house later? If you are paying down credit card debt, would you rather pay $200 above minimum or set aside some of that money, like $100, for an emergency fund? If you are saving money, would you rather keep it as cash or invest in bonds / stocks?

How do you go about making the right choice? The best way is to plan ahead. Plot out your future goals, and then calculate what you need to do to reach your target. If you have a complex situation that requires professional advice, look to the help of a financial planner or coach. October just so happens to be National Financial Planning Month in the United States, so what better time to start planning!

Homework: What are some financial decisions you need to make? Test each decision by asking “Would You Rather?” Are there any decisions worth changing?

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A Tale Of Two Investors

Investing at an early age was one of the best things that happened to me. It propelled my understanding of money, but it also helped me gain an interest in money. Not just any kind of interest. Compound interest. Much like a flower, money requires time in order to blossom. Of all the things money can buy, it can’t buy time. That is why investing early is so important.

To illustrate the difference between investing early and investing late, let’s read a little story about Investor A and Investor Z.

The Early Investor A

Investor A sets aside $1,200 / year (or $100 / month), beginning at age 22. Since the money is intended for retirement several decades later, Investor A takes an aggressive stance and invests in the stock market, yielding 7% interest per year. Thirty years later, at age 52, Investor A chooses to stop saving any more money, but keeps the investments for another 10 years until age 62. After 40 years (saving for 30 of those years), how much has Investor A accumulated?

Cash In: $36,000

Cash Out: Approximately $223k

The Late Investor Z

Investor Z waits until age 32, or 10 years after Investor A, to start saving. At the same investment rate of $1,200 / year with a 7% market return, Investor Z continues all the way until age 62. Thirty years later, how much has Investor Z accumulated?

Cash In: $36,000

Cash Out: Approximately $113k

Doing The Math

Based on this story, foregoing 10 years of market gains costs Investor Z about $100,000. What if instead Investor Z chooses to save more money due to a late start? To reach $223k in thirty years would require saving $2,360 / year (or $197 / month). That means more cash in: $70,800 ($2,360 x 30 years), instead of $36,000 ($1,200 x 30 years). And to think, time alone could have made that!

While this story demonstrates the value of getting an early start on investing, late bloomers should not be discouraged. If anything, this is a lesson to start investing as soon as possible. The more time goes by, the more you miss out on growing your money. Keep in mind that investments go up and down, so having more time to smooth out the dips also helps. Overall, working with a long time horizon certainly benefits you more than investing over a short time horizon. How would you like to see your money double, triple, or more without adding more money? The key is to start NOW!

Homework: Do the math. Find an online calculator or use one from your financial institution to determine how much you can accumulate if you start investing now. What would it look like if you wait 10 years to start? How much more would you need to save to get the same end result?

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