Decoding Opportunity Costs

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Nictionary Time.

The term “opportunity cost” is a bit misleading (who’s surprised? I feel like I give that caveat all the time in this loopy financial world). Investopedia defines opportunity costs as: “the forgone benefit that would have been derived from an option not chosen.”

Let’s put that into plain English. Opportunity costs refer to the consideration that you should make when you’re about to spend money— specifically, considering how that money would have worked for you if you used it in a different way. Most commonly, people reference opportunity costs when they are about to make a big purchase, and evaluate how that money would work for them if they invest it rather than spend it.

Case in point: let’s say we both have $100,000 right now. I decide I’m going to ball out and rent an apartment that will cost me $100,000 for the year— or, around $8,000/month.

You decide to put your $100,000 in the stock market. Assuming stock return rates stay at around 8%, after twenty years, your stocks are worth a little over $466,000 and I am two million dollars in the hole from balling out on rent.

So let's rewind those twenty years— when you and I were talking over what to do with our 100,000 dollars, and I told you that I was going to drop it all on rent, you might say something to me like: “Nicole! But think of the opportunity costs!” And I would say...

Considering opportunity costs is how you look out for your future financial self— and how you hit that sweet spot in your financial mindset between thinking you’re going to die tomorrow and planning on living forever… But I know that’s not always easy.

When you’re reading the Money Minute, you’re probably really freakin’ motivated to get your financial future together. But when you shut your computer or turn off your phone, do you keep that motivation going? It’s one thing to be all gung-ho about your future self when you’re on the road to financial freedom and I’m waving a flashing neon “START INVESTING NOW” road sign; but it’s another to keep focus when I’m in your rearview. So how do you keep that motivation going?

I solve this motivation problem by considering my investments as specific acts of kindness for my future self. The key for me here is being specific. Whenever I’m tempted to skip a month of my investment or retirement contributions, I’ll say to myself, for example: this contribution is for my old lady self to buy herself beach chairs, a picnic lunch and a bathing suit to have herself a proper beach day—plus, an Uber to get to the beach and back. I’ve found that if I assign my retirement contributions to specific spending allowances for my future self, even if that assignment is just in my head, I’m much more likely to do it.

If I get a little bonus cash thrown my way and I’m contemplating whether buying myself something nice now or later—sure, I’ll give myself a small indulgence now, but I’ll put most of it towards my future. And I’ll say to myself (sometimes even out-loud, because I’m that weirdo): “You know what, old lady Nicole, take yourself out to dinner.” Or, “Hey future self, you buy yourself something pretty, girl.” The future is always uncertain, but I can be certain that my 70-year-old self will say back “Thank you, past Nicole” and take a little extra sip of that bubbly to thank me for the work I’m doing now.

xo,

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