Opportunity Costs and Conscious Spending: How Spending $1 Today Can Cost You $10 Tomorrow

by J.D. Roth on 22 April 2014 3 comments

Every time you make a choice, there's a cost. By choosing to buy one item, you pass on the opportunity to purchase other items. By choosing to do one thing, you pass on the opportunity to spend your time in any other way. Opportunity cost is what we give up in order to have the thing we choose. (See also: Decisions With Unexpected Financial Consequences)

Imagine you own a delivery company. You have $10,000 to spend on new equipment. You could buy a new truck to add to the fleet, but then you wouldn't be able to replace the 10-year-old computers in the main office. Conversely, if you buy new computers, you won't have as many trucks available to make deliveries. No matter which option you choose, there's an opportunity cost.

While this concept is applied constantly in business, it's often overlooked in personal finance. When your household uses money for one thing, that money is unavailable elsewhere. If you purchase a home with a $1500 mortgage, for instance, you can't use that money to travel or to fund your retirement.

Opportunity costs are neither good nor bad. They're simply the price you pay to have what you choose. The problem comes when the choices you make aren't intentional — when you make them out of reflex or habit.

Every time you spend money, there's an opportunity cost associated with it. But you're not just sacrificing other choices in the present; you're also sacrificing your future freedom.

Consider this: A dollar saved is worth more than a dollar spent. In the United States, where the tax burden is low compared to other countries, the average worker must earn $1.33 to have $1.00 left over. (In some countries, a worker might have to earn $2.00 to have $1.00 remaining.)

It gets worse! If you spend a dollar you might have invested, you don't just lose that dollar but any future return you might have earned on it. Assuming typical stock-market growth, that dollar would have a value of $1.93 ten years from now — and $7.20 in thirty years. (See also: How the Time Value of Money Affects You)

Let's put these two facts together: You have to earn more than a buck to have a buck, and if you spend that buck, you're also spending its future value. On average, each dollar an American spends represents $2.57 of value in 10 years or $9.57 in 30 years. (If you live outside the U.S., the consequences of spending that dollar are probably even greater.)

To make things easier, just approximate: The opportunity cost of spending one dollar today is ten dollars you could have had in retirement. I recently had a chance to chat with Tom O'Donnell, a senior vice president at Chase Bank. We talked about personal finance and our shared interest in travel. O'Donnell told me that a lifetime of saving has bought him freedom. "I get to choose what I do now because I saved when I was younger," he said.

Viewed this way, it's easier to see that saving isn't deprivation. When you save, that money's still spent. It's just not spent on a Mercedes or a big house. It's spent buying your future. The opportunity cost of starting late, a foolish purchase, or a bad investment isn't lost income or lost compounding. It's lost time — lost experience and lost life.

I'm not arguing that you should live like a monk. Far from it. But it's important to consider the opportunity costs of every purchase you make. When you do buy something, you should do so intentionally because the opportunity cost of buying on impulse is enormous.

I endorse a concept called conscious spending, which I learned from Ramit Sethi, author of "I Will Teach You to Be Rich." "Being a conscious spender is about making your money match up with your values guilt-free," Sethi says. "It's about spending extravagantly on the things you love while cutting costs on the things you don't." (Some experts use the term "mindful spending" to refer to the same concept.)

Conscious spending means actively choosing to spend on some things and not on others. Contrast this with how most people spend. (And, in truth, how even the financial experts spend a lot of their money.) People tend to spend on reflex.

We buy things because we're expected to. We spend to have what other people have. We sign up for gym memberships that we never use, subscribe to magazines we never read and pay for golf clubs that get buried in the garage. We make impulse purchases at the grocery store — or even on large items, like computers and cars. In other words, we often spend without thinking. (See also: How to Stop Online Impulse Spending)

The opportunity costs of these unconscious purchases are significant. We're sacrificing our futures for lesser pleasures today.

With conscious spending, you evaluate every purchase, asking yourself: "Why am I buying this? Will it make me happier? Will this help me meet my long-term goals?" "Would I rather have this now, or would I rather have something bigger and better next year?" "Are there other, cheaper options? Could I borrow this? Could I buy it used?"

Conscious spending forces you to become more aware of every purchase you make.

I'm willing to spend $200 each month on gym and fitness programs because doing so has helped me to lose fifty pounds and become fit. I've made an active, conscious decision to spend this money, and I've made certain that I'm deriving value from it. I recognize that I'm sacrificing a great deal in the future, but I believe my improved health is a worthwhile reward that will lead to a longer life.

On the other hand, I'm unwilling to own a new car. Financial considerations aside, I don't care enough about features and flash to make such a purchase worthwhile. For somebody else, though, the car might be a worthwhile purchase and the gym membership a waste of money. (See also: Little Luxuries That Go a Long Way)

"There are things we love, and it's okay to spend on them," says Sethi, who also writes at iwillteachyoutoberich.com. "But you can't afford to have everything. So ask yourself what you don't care about when it comes to spending. Choose to spend your money on what you love instead."

When you spend, be sure it's aligned with your purpose and mission.

This is a modified excerpt from "Be Your Own CFO", the 120-page guide included with the year-long "Get Rich Slowly" course. The guide includes tips for boosting revenue and cutting costs so that you can maximize profit in order to achieve your dreams, whether those are to retire early, send your kids to college, or travel the world. Want to know more? Buy it now.

This is a guest post from J.D. Roth, who founded the blog Get Rich Slowly in 2006. Roth wrote Your Money: The Missing Manual and is the "Your Money" columnist for Entrepreneur magazine. His latest project is a year-long course on how to master your money, which explains how to slash costs and boost income so that you can pursue early retirement and other goals. This article is one piece of this course.

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Guest's picture

"People tend to spend on reflex."

Well put. Mindless spending on stuff and services "just because" is a huge drag on available funds and an individual is not likely to derive lasting value from it. By becoming far more mindful of our spending we now:
1. spend far less than we earn
2. are happier in general with what we do spend on
3. experience far less financial stress or worry

Guest's picture

Great piece. The time value of money is important and the sooner we spend our money, the sooner we give up the future value of our money. Conscious spending is a great way to nip that in the bud and provide ourselves future financial security.

Guest's picture

Great post. So many people are blowing money on the here and now instead of building a secure future. Seeing my own parents struggle financially is a good motivator to ensure that I don't end up in the same situation someday. I do think that "spending extravagantly" on certain things is important -- if we're miserable because we've deprived ourselves of everything, chances are we'll burn out and give up. But we can't have it all.