To buy or not to buy?
Have you ever spent money and wish you hadn’t? Do you look at your bank account/investment account/retirement pot and think ‘there really should be more’? Science tells us it may not be your fault. The thing is, our brains only have a certain amount of computing power. And when it comes to money we are wired to act irrationally. That’s because when we spend money on something it is impossible for us to analyse rationally all the other things that we could have spent the money on, either today or in the future. There are literally millions of other things we could have chosen to buy with that money, or we could have not spent it at all in that moment, and spent it on a million other things next week, next year, or next decade. Confused? It’s called opportunity cost. When we spend $100 on a new pair of shoes, we don’t have that $100 to spend on something else. We can use money for so many different things, now and in the future, that it is very hard for us to see what we are giving up when we buy the shoes. What we need to be able to do is work out how that $100 would give us the most amount of happiness, but the analysis is so complex our brains can’t come to a conclusion. So what do we do? We buy the shoes of course.
Opportunity costs hit us in many parts of our life – it is the benefit we could have received if we had taken a different course of action. If we hadn’t bought the shoes, we could have put the money in our investment account and seen it grow. Sallie Krawcheck wrote a piece this week about opportunity costs in our career.
Firstly, what is the opportunity cost of NOT asking for the raise? The pay gap is real and it costs us A LOT over our careers. I am not going to get into a discussion of why it exists or what we can do to close it, but not asking for a raise when you know you deserve one costs you way more than you think. Perhaps millions, even many millions (think about what would have happened if you had asked for the raise, got it, and invested it).
What about the opportunity cost of a career break? I have written about that one before. It’s huge.
And the one closest to my heart – the opportunity cost of NOT investing. I know keeping your money in cash feels safe, I know that, I really do. But it’s not safe because, although the figure in your bank account always looks the same, you are able to buy less and less with your money as each year goes by. You are not maintaining your purchasing power because things around you are getting more and more expensive (in general) and your money is not growing in line with this inflation.
Let’s put some figures on it. I love figures. To take an easy number, let’s say you have $100,000 in cash, over and above what you need in your ‘emergency reserves’ (my advice is always to keep at least six months’ living expenses in cash). You do nothing with your cash and leave it in the bank earning no interest. In twenty years’ time, you still have $100,000. Now here is the interesting part. If the cost of living over that twenty years has doubled (about what has happened historically), then your money has halved. It’s worth $50,000. You still see $100,000, but you can only buy half as much stuff. What would have happened if you had invested the money and earned a 7% return after inflation? You would have almost $400,000. So, $50,000 or almost $400,000. That’s your opportunity cost over twenty years.
Growing your money is a pretty cool thing to do, but it doesn’t always feel comfortable. That’s why I love to make the investing experience fun, and not in the least bit scary. And I do that through knowledge. When you understand why you are doing what you are doing, you move from fear to confidence. You feel in control.
Sound good? Drop me a line and let’s nail that opportunity cost.