Everyone likes to indulge from time to time. Even the most financially responsible among us gives in to the temptation for a gratuitous new gadget, expensive dinner or designer accessory every once in a while. Because unrelenting frugality is too difficult for most people to maintain over a lifetime, it is essential to have a method for determining when it is okay to splurge and when it is time to kick your willpower into overdrive.
Like everything else, the decision to save or spend goes right back to the most fundamental of economic problems. In a world with unlimited human needs and wants, we are faced with decisions about how to use our limited resources. The first time a child receives a dollar and decides to spend it on candy, he or she is unwittingly participating in economic decision making. Each decision involves options; the option you choose is the opportunity benefit, and what you miss out on by not selecting the next best choice is the opportunity cost.
Many of you probably already engage in some type of cost-benefit analysis before making major purchases, but merely considering the sticker price of an object overlooks the much greater long-term opportunity cost.
Consider the following situation:
You have had your eye on the latest and greatest widget for almost a month now. You know you do not need it, but that does not decrease your desire to have it. The price of the item is $1,000, but what is the real cost?
In order to make accurate calculations, first you must change your mindset to begin thinking of every dollar as a potential investment opportunity. If instead of purchasing the widget, you were to invest the money in the stock market, based on historical averages you could expect annual returns of about 5% adjusted for inflation. For a person in their mid-thirties with thirty years until retirement, the original investment will have more than quadrupled. The widget that originally cost $1,000 resulted in a long-term opportunity cost of over $4,000 in today’s dollars.
Was it worth it? Maybe or maybe not.
That depends on the product in question and its value to the beholder, but it certainly helps to put the decision to save or spend into a better perspective.
The same rule applies for that new purse or pair of sunglasses- $300 is already a hefty price tag, but what about $1200 in lost retirement savings?
Calculating the cost for recurring expenses is even more staggering. Take for example the typical spa manicure and pedicure. For regular clients, the bill with tip comes to at least $75 per month. Multiplied by twelve, the annual cost is $900. Over 35 years, after calculating lost investment returns, you are looking at a $90,000 indulgence.
What about eating out instead of dining in? Think about how much you spend on restaurants and takeout food each month- $200, $300, even $400? Multiply that figure by twelve to get your annual cost, and then by 1,000 to calculate lost opportunity over 35 years. $240,000+!
With that in mind, the next time you pull out your wallet to make a purchase, try looking beyond the number printed on the price tag. By thinking of every nonessential purchase as a lost investment opportunity, the decision to save or splurge suddenly becomes a lot easier.