Opportunity cost, what is it and why should I care?

Opportunity cost, what is it and why should I care?

Over this past Easter weekend we as a family went on a 4×4 eco-trip through the Kruger National Park.  It was an amazing experience!

What wasn’t so amazing was the fact that, the night before entering the park while we stayed over at a guest house, my wife wanted to cool her feet off in the guest house swimming pool, but slipped and in the process dropped her iPhone in the water.

Swimming Pool : 1  iPhone : 0

After the trip and back home in sunny Centurion, we discussed the replacement decision we’re going to make.

  1. Buy a new handset, like a lovely iPhone 8 or even the flagship iPhone X?
  2. Buy a certified pre-owned (CPO) model?
  3. Go back to a 24 month contract, just to get her hands on a new handset and lock herself into a 2 year contract again?

 

A few years ago we might have decided to use this as an excuse to get her something new and shiny (victims of consumerism?), but we’ve since learned the meaning of opportunity cost.  So what we did was to replace her old iPhone 6 with a CPO iPhone 6S, which we got at a very good price.  Barring any further unscheduled scuba-sessions for her phone, she should be good for the next few years.Opportunity Cost

So, what is opportunity cost and how did it influence our decision?

Opportunity cost is the loss of other alternatives when one alternative is chosen.  What this means is that, if you have to decide between a R5000 iPhone or a R15000 iPhone, by committing the extra R10000 to the purchase means that you can’t utilise the R10000 to purchase something else.

So what, you may ask?  The thing is, if you spend your money on buying things that lose value (phones are a perfect example) and you don’t spend it on buying things that increase in value (for example an Index Fund), you’ve lost the opportunity for your hard-earned cash to work for you.

This is profound.  Just think of all the money we tend to throw into buying value-losing things like expensive cars, big houses, big-screen TVs, expensive DSTV subscriptions and the like, even financing a lot of these purchases, when we could have made better purchases and directed our money towards investments instead?

So, how do you change your mindset so that you can resist the temptations of consumerism?  What I’ve internalised in recent years are the following:

  • When you buy anything on credit, you’re effectively borrowing money from your future self (making your future self poorer in the process)
  • When you invest money, you’re effectively paying your future self (making your future self richer)
  • When you make any purchase, calculate how much of your time you’re paying for this item.  That is, not how much of your money, but rather how many of your working hours were you required to slog away at work to make enough money to finance the purchase?

When keeping these three points in mind before any purchase, the impulse to make the purchase goes down dramatically and I find it a lot easier to just say no (or to find cheaper alternatives that will still meet my needs)

By just keeping opportunity cost in mind lately, we’ve been able to dramatically cut down on our spending, which in turn pushed our savings rate up dramatically, and thus the amount of resources we’re directing towards our investments.

I hope some of you might find this helpful, it really changed our lives for the better and started us on the path to reaching our goals earlier!

Hamster

9 thoughts on “Opportunity cost, what is it and why should I care?

    1. Yeah, no need to always buy the latest and greatest, to the contrary, getting that model that’s one or two generations old (but still in perfect physical condition) is great value for money!

  1. Opportunity cost should be back of mind with every non-essential purchase, but should be front of mind for the really big stuff, like cars, coz now we talking what could end upi being Millions of rands!

    P.s. super cool to have a fellow personal finance blogger from Centurion! Where about are you?

    1. Hey Stealthy!
      Yeah I’m completely new to the blogosphere, so learning as I go along. Hopefully my content will improve over time as I work on my writing skills. But so far I’m enjoying the process of putting my thoughts into words, especially the fundamental a-ha’s I had that changed my financial path for the better.
      I’m in the west of Centurion, not far from Mall@Redds. Where about are you?
      Hamster

  2. I love the idea of looking at opportunity cost as rewarding or stealing from your future self.

    We should keep our future self front and center in all of our decisions because our old self is a lost cause.

    Also I remembered that I owe you a comment on ways to increase traffic. Write good articles and Just hustle. All the technical things (SEO, keywords, etc) are good but don’t really increase traffic in the first year of the blog. Growing your twitter following, getting active on FB and commenting on blogs will get people to your site.

    1. Yeah, I’m still quite new to the Blogosphere, but have been doing exactly what you advise and my traffic has been picking up slowly but surely. Will just have to out more time aside to write good articles, but as you know, 24 hours in a day never seems to be enough! LOL

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