Opportunity Costs

The loss of potential gain from other alternatives when one alternative is chosen.”

Earlier this week Rachel and I were sitting in the sun on the back deck after work. The weather had taken a dip towards the cool so we were not in the pool. It’s not uncommon during our end-of-day unwind that we listen to a portion of a podcast or I read to her something that I’ve read earlier in the day (over an adult beverage of course). I read to her fairly often; parts of some article or book that I find insightful or interesting. It can be a good conversation starter. We typically unpack what we listen to or read, and try to see how it fits into our lives, if at all. Many times we find that the information can have a much broader impact than perhaps was originally intended.

This particular afternoon I was reading a small portion of The Simple Path to Wealth by JL Collins. I’ll admit to not being very smart about money. I wasn’t raised with any sort of money-awareness. I mean, working hard and paying the bills was the right thing to do, but that’s about as far as it went. No one I knew ever talked (or knew anything about) the stock market. I never heard the terms 401K or return on investment (ROI). Debt was fine as long as you could make the payments. There was not a great sense of driving yourself towards higher goals or being a life learner; I was discouraged from pursuing my dream of being an attorney because they were all “educated idiots.” Mediocrity was perfectly acceptable. My upbringing in that area is probably not unlike some others who are now coming into middle age.

I’ve left most of that behind now; except the part about not (still) knowing much about money and investing. Rachel and I are learning fast, and as we move towards becoming debt free, we want to make smart decisions. We want to be well-informed about all things financial. Once we reach our debt free goal, we should have a very sizeable amount to invest monthly and we want to make sure we’re doing it right. So, after I read an article from an author that I respect that listed Simple Path as one of his foundational readings, I ordered it from Amazon and downloaded it to my phone (so I could read it in the hot tub of course).

I didn’t get very far into the book when I came upon this idea of opportunity costs. I thought I knew what it meant (I didn’t), and the whole concept rocked (is rocking) my world (in more areas than just financial). I’m still fleshing it out.

In chapter 4 of the book (this is what I was reading to Rachel), the author talks about buying a car. Once that car is purchased, the money is spent, and there is an opportunity cost to no longer having that money available to work for me. Financially speaking, opportunity cost is what I give up (lose) when I choose to tie up my resources (money) in one thing (car) over another thing (an investment). The car money (a study in depreciation) won’t be “working” for me in the future. If I had invested the money, it would “work” for me by creating earnings at (maybe) 8-10%, and that money would then make more money, and so on and so on. So in the end the car costs me alot more than the actual price because I both pay interest to the car loan and I don’t earn investment interest. Run that out for 20 years and there’s a huge disparity. I suppose if I had used the car to be the getaway driver for bank robbers, the money might in some way still be “working” for me (if you knew how slow I drove, this would be hilarious and a non-option).

It’s this idea of opportunity cost that really set my head spinning. It’s about alternatives and the way the choices we make run out into the future; both the alternatives we say yes to and the ones that we say no to.

We could have chosen to purchase a bigger Baby House in Mesa. We had that option. But then the extra money that we spent on the higher payments could not be used towards getting out of debt. The money that I chose to spend in obtaining my first Masters degree might have been better invested to create returns. We could have chosen to spend 30K updating the kitchen (the architect had the plans all drawn up), but we chose instead to spend 10k and focus on the real needs. We could have chosen to purchase a newer and more expensive motorcycle, but then we could not have used the extra money towards debt (and I wouldn’t look nearly as cool).

I could have chosen to purchase the Super Duper Double Barrel Master Blaster Wasp Annihilator Spray for the back yard wasps, but there are much less expensive (and less deadly) options and, again, that money can be better used (and the neighbors won’t start dis-inviting me to the barbecues).

The idea of opportunity cost is that options we select create the potential for loss of gain, and it’s a really good idea to consider the options before choosing the path. Is there a better way?

It might sound like I’m advocating for never spending, or spending less, or eating rice and beans until financial independence is achieved (although I kinda like rice and beans). That’s not it at all. Rachel and I have really beautiful things. Truthfully, we could have not bought the Baby House (alternative 1) and used that money to get out of debt even faster (alternative 2). We then could have invested more and sooner (alternative 3), and that money would go on making more money essentially for the rest of our lives. So in the end the opportunity cost of the Baby House will be more than the purchase price, probably alot more. Even with that, we would make that choice again in a New York minute. That opportunity cost is worth every cent and pays every year non-monetarily: helping us escape some of the Idaho winter. It brightens us, gives us hope, and has opened a whole new world of potential.

Not all things are about money. Life is not just a monetary excursion or just about amassing bags of money. Looking back in regret at life can be frustrating, and quite honestly, largely a waste of present life. It only has value if a lesson can be learned and used to make the future better. A lesson can be a very powerful tool. Move on. Do better.

Also, sometimes things just don’t “feel” right. And sometimes things do just feel right. The 30K kitchen didn’t feel right. All of the fifth wheels and monster trucks to pull them so far just have not felt right. Despite the dream, it might be a path we choose not to go down. If we had bought the fifth wheel or truck or more expensive kitchen update, we would not have been able to afford the Baby House. And although I’m also not advocating for sitting cross-legged on the floor and making decisions based on Zen, there is a “gut” that’s valid and should be listened to.

Additionally, Rachel and I are noticing that our age is becoming a significant factor in our consideration of options. As we move into this thing called mid life, we’re understanding that we probably have less time to fix a mistake (even though I’m going to live to be 106). By default, it’s making us more cautious.

What I’m really trying to focus on is understanding that our choices, both financial and non-financial, can earn “interest,” and are both manifested and magnified in life. They create results that last for a lifetime. Like the picture at the top of the post, choosing one path means we can’t choose the other. And down that path will be more alternative paths to choose. We probably can’t ever get back to the other path, and even if we do, we’re changed people.

Every decision creates potential. There are benefits and detriments, advantages and disadvantages. Choosing one means that we negate the other. There is a cost to our decisions, and sometimes the cost is worth it and sometimes not. But it’s always a good idea to work that out and know the cost as best we can.

Opportunity costs are cool to think about. I want to apply the paradigm as we move forward, especially now that middle age is upon us and we’re preparing for our non-working future. While that still might be some years off, I’m finding that even in the daily decisions it can be beneficial. Food choices, activity choices, thought choices, word choices; am I at least trying in some small way to be better than I was yesterday, to factor out the effect of my decisions into the future, to choose better paths? In the long run it could really make a difference.

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Observations, lessons learned, perspectives, and anecdotes from the Grand Adventure of Middle Age as Rachel and I chase our dreams. I welcome you to follow along and join the adventure.

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