Saving Tip: Assign An Opportunity Cost to Everything
I first heard of the concept of an opportunity cost in my Economics 200 class in my undergrad. For those unfamiliar, the concept in simplicity is considering what you would be giving up for something else. I had thought about what we choose not to have when we choose to have something, but didn't know that it had a fancy schmancy economics term.
Buy a $250,000 home as an investment property with cash.
The opportunity cost is anything else that you could do with that amount of money, be that an experience, a different asset, an object, perhaps even starting a family. It could be buying a new Ferrari and going on a two year North and South America touring cruise with your best friend or significant other.
Now, it's important to know that whether you acknowledge and think about it or not, everything you do has an opportunity cost - not just financial, but decisions as well. We'll stay focused on financial opportunity cost for now.
The advantage in saving comes from thinking about that opportunity cost in the most impactful way whenever you make, or are about to make, a purchase of any kind. Typical expenses abound here give you incentive to reach for the highest option available. When you pay rent, you are foregoing and giving up on the opportunity to be paying a mortgage instead. One adds to equity, and can be considered an investment. The other is simply a cost you pay in exchange to live. When you put things into perspective such as this, the better option becomes clear right away. Often times you can't explicity trade one for the other with an amount of ease, as in the example I just gave - in order to be paying a mortgage instead of rent, you need to have a down payment, and perhaps other costs associated with furnishing, inspections, and all the other costs that go with buying a new home when upgrading from a rental. You also now bear the burden of paying for your repairs on said home, so an opportunity cost doesn't always solve more problems than it gives.
Due diligence in considering all of the consequences that go with an opportunity is part of the process of analyzing all of the options before you. Ask yourself:
What am I giving up in order to pay for this?
If I went with the other options what would additional costs and consequences be?
Should I start a plan now to move on the opportunity as soon as possible, or is my original assessment still the best option?
Each purchase that you make in your life, every withdrawal has an opportunity cost both ways. Even if you decide to cook your food at home, your opportunity cost there is missing out on meals and experiences you might have if you instead went out to dinner with friends. When evaluating these opportunity costs, simply select the one that gets you what you want in the long run - or at least closer to it.
For me, it's financial independence.
What about you?