The Opportunity Cost Formula

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The most expensive thing in our life is the one thing you don’t see.

It’s the one thing that will have the largest impact in your life.

It’s the one thing you are in full control of at all times.

It’s the one thing you can’t go back and fix.

It’s safe to say it is the the most important cost in your life.

Opportunity Cost

Everything has an opportunity cost attached to it. Let’s say you want to go out and buy a brand new pair of shoes for $100. I’m not saying this is good or bad, but I am telling you that the $100 you spent on shoes is costing you more than just money, it’s costing you the O-P-P-O-R-T-U-N-I-T-Y of doing something else with that money.

What if instead of buying that pair of shoes, you instead decide to pay off debt with it? Therefore, the opportunity cost of purchasing those shoes is costing you the opportunity of paying off your debt quicker.

This seems pretty obvious when we talk about small numbers like this, but what about when we add a few zeros to the mix and then tack on time?

This is where opportunity cost matters.

 

The Opportunity Cost Formula

Below is an example of how to apply the opportunity cost into any and all financial decisions you make.

 

Samantha is 35 years old and facing $45k of debt at an average of 24.99% interest.

She can afford to currently pay $1,000 per month towards her debt, which means she will be debt free in 11 years and pay a total of $132,000 on that $45k debt.

 

How is this possible?

  • $1,000 for 11 years = $132,000

 

  • $45,000 principle + $87,000 interest = $132,000

 

Ouch is right…

 

Keep in mind, this means she doesn’t pay a penny extra for 11 years and never borrows money again during this period.

Not a great plan Samantha.

 

What Can She Do About It?

She begins to look at areas in her life where she can cut back. She looks at some of the luxury items in her life and realizes she is paying:

 

  • Cable Bill – $130/month

 

  • Dining Out – $500/month

 

  • Clothes Shopping – $350/month

 

  • Yoga Classes – $100/month

 

  • Magazine Subscription – $20/month

 

Total: $1,100/month

 

Samantha decides to see what the opportunity cost would be if she were to cut back her lifestyle in these areas of her life in order to pay off this debt faster. Here is her proposed plan:

 

  Was Now
Cable $130 $0
Dining Out $500 $200
Shopping for Clothes $350 $100
Yoga Classes $100 $0
Magazine Subscription $20 $0
Total $1,100 $300

 

Total Saved: $800/month

 

Now, Here is the Opportunity Cost

If Samantha applies that extra $800 in addition to the $1,000 she is already paying towards her $45,000 debt, she will have her debt paid off in 3 years. She will also save over $67,000 in interest!

 

Opportunity Cost of cutting back her lifestyle:

 

  Was Now
Money $132,000 $64,800
Time 11 years 3 years

 

Total Opportunity Cost: Savings of $67,200  and 8 Years of Payments

 

However, it doesn’t stop there. This little hidden opportunity cost pokes it’s head up again…

 

Since Samantha cut out 8 years of making debt payments to the bank, she now has that same $1,800 a month to do whatever she wants with. She can go back to cable, go back to dining out full time, and start attending her Yoga classes again.

 

Or, she can look towards the Opportunity Cost once again…

 

She realizes she is now 38 years old and decides to look at what life would be like in 8 years if she were to invest that money instead of reapplying it towards her luxury items.

 

What would life look like if she invested that same $1,800/month into a mutual fund for 8 years at an average of 8% annual return?

 

Answer: $240,000

 

Let’s add this to the $67,200 she has already saved from earlier:

If Samantha decided to stick with the bank’s plan of paying $1,000 towards debt for 11 years, her Opportunity Cost would have been $307,200!

 

 

How is this possible?

Total Savings adding $800/month towards Credit Card Debt: $67,200
Total Saved after investing $1,800/month at 8% annual return: $240,000

Total Opportunity Cost: $307,200

 

Opportunity Cost is the greatest expense you can't see or feel right now. So, you better PAY attention. - Chris PeachClick To Tweet

 

This is Why Rich People are Rich

Rich people are rich because they understand opportunity cost.

They see the invisible part of money that poor people don’t see until it’s too late. They understand every time they are spending a dollar on one thing, they are giving up the opportunity to apply that dollar somewhere else in their lives. They simply choose to get it.

 

According to the book, The Millionaire Next Door by Thomas Stanley, the average millionaire in America:

  • Is first generation wealthy

 

  • Lives on a monthly budget

 

  • Has a 15 yr mortgage versus the 30 yr mortgage

 

  • Maxes out their 401(k)s every year

 

  • Drives a 2 year or older car

 

  • Works between 45 – 55 hours per week

 

  • Is always looking at the Opportunity Cost

 

“One of the reasons that millionaires are economically successful is that they think differently”

-Thomas J. Stanley, The Millionaire Next Door

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It Works Both Ways

I am fully aware of opportunity cost. I breathe it, sleep on it, wake up to it, and think about it in every aspect of my life, not just money.

Yes, quite nerdy…I know 🙂

A few summers back we actually bought a boat. The Peach’s wanted a boat and we saved up cash to buy a used, but very nice boat for the family.

The opportunity cost of purchasing that boat cost our family the opportunity of investing more for our retirement and for our kids’ college.

Andrea and I went as far as to look well beyond the cost of the boat, and included the cost of the monthly upkeep, the fuel costs, and all those little (giant) costs of owning a boat. We then looked at the entire opportunity cost of buying a boat versus investing more into our retirement accounts.

We bought the boat anyway. 

Why?

Because the opportunity of the family together on the lake each summer outweighed the opportunity cost of missing out on a small portion of investing over time.

It wasn’t the right or wrong choice, it was simply our choice.

 

You’re Not Wrong if You’re Not Right

 

You show up to work, you make the money, therefore you have to decide what to do with the money.

-Chris Peach

I tell this to my coaching clients and my Awesome Money Course students all the time. Often times people will believe that you must be saving money, you must be investing money, or you must be doing something better with money than spending it on ______.

Well, that’s just simply not the case. It’s your choice to do what you please, however I am going to encourage you to do things with money that will allow you to obtain your goals in life.

If your goal is to own 5,000 pairs of shoes by the time you are 65, then please, by all means, start buying shoes right away!

However, if your goal is to retire a debt-free millionaire so you can live, give, and enjoy the hell out of life in your resting years, then understand the opportunity cost for each and every dollar you spend.

You Know You Love it!

I am here to help, to provide massive value, and most importantly, I am not going anywhere.

I want you to win with money and I want you to take a piece of information from this website and implement in a way that makes sense for you.

The absolute best way to tell me I am helping you is by leaving me a comment below and sharing this on your social media by clicking on any of the icons above.

This money stuff isn’t taught anywhere and it needs to be on the minds of people just like you. What would the world be like if we didn’t have debt payments each month? How would people feel if they no longer had the stress about money? How much more fun could we have if money was no longer the #1 problem in life?

Someone out there needs to see this. It’s helpful, it’s needed, and most importantly – you get to help get the word out.

Thanks for your loyal support,

 

-Chris Peach

 

 

7 Comments

  • It is a great way of looking at things. My husband and I moved to a better school district to get our son out of the school he was in (that wasn’t very good), but it was much more expensive to live in the new area. He managed to get into a good college but had to get student loans to pay for it because we were not diligent enough to save a lot for college. Looking back, I am not sure the move and the subsequent years of taking on extra jobs and longer work hours to pay for things was worth it. I am working on paying off student loans now and will try to put your example into play and see how much faster I can get that accomplished. Thanks.

    Reply
    • Hi Jill!

      When you start looking at the opportunity cost with money, you are going to quickly realize how wealthy your really can be if you stop ________. The best piece of advice is to pull of the rear-view mirror and only look ahead from this point forward. The past is just that – the past. You can’t change it, so don’t beat yourself up over it. From this moment forward, realize you have the opportunity to look at and feel the opportunity cost 🙂

      Reply
  • I’ve been looking forward to find a way of changing my “relationship with money” and budgeting, my debt is not that high, thank God, and don’t want to get to a “point of no return”, so I took a choice, I decided to start today, and looked for articles and tips to have healthy finances, and there was this site, loving the fact that I’m able to start TODAY. As you mention, it’s all about choices, and I’m sure this kind of knowledge will lead me to better choices and, most importantly, more happiness.

    Reply
    • Hi Gabriela!

      You’re in the right place and you’re taking a HUGE step in the right direction by simply starting.

      With that said, head to the cash flow formula to get started with the the first step to financial freedom.

      Here’s a Fist Bump from me to you Gabriela! Nice work 🙂

      Reply
  • Hello Chris,

    Today’s post literally brought tears to my eyes. I had not realized how selfish I have been by indulging in luxury items (when the opportunity arises –not all of the time, but, nonetheless, there is no real difference here), and not thinking of the “opportunities” that I should, instead, focus on. Opportunities that affect my family and my new grand baby, not to mention consideration of my husband’s and my future retirement. We are currently working out of the country, but we will definitely seek your personal services upon return. Thank you for your generosity in sharing your experiences to make our lives better.

    Reply
    • Hi Alma,

      It’s tough not to get a little emotional about it because you tell yourself “only if we had done ______”. Here is the deal – I want you to stop looking in the rearview mirror. It no longer matters anymore. Instead, start looking at what life WILL look like from this point forward if you understand and implement opportunity cost. The best thing of all: it’s your choice. You get to decide.

      Thanks for your comment Alma!

      Reply
  • Great post! I often think about the opportunity cost of things before we spend a large amount of money on something. I think it really helps us to make wise financial decisions.

    Reply

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