Opportunity Costs

Happy Holiday weekend everyone! I have been looking forward to this post all week. It is something that I think about a lot and something that Mrs. Sloth and I come back to when we are weighing a purchase.

Investopedia defines opportunity cost as “…a benefit that a person could have received, but gave up, to take another course of action.”

So this is a cost we incur with every decision we make right? Like, that extra scoop of ice cream, or that double shot instead of a single represents something we could have spent that money on either now, or more importantly, in the future.

As a lot of folks correctly point out, you can’t save your way to wealth, but what is the real cost to us of NOT saving all those little pennies here and there? In this post, I want to share some stories with you all and provide a little data to show what those lattes are actually costing us.

So way back in the day when Mrs. Sloth and I started dating, we were at the grocery store. At the time we lived in a city with a bag tax of $0.05 per bag. We had bought an amount of groceries just a bit too awkward to be stuffing into our pockets and did not have a reusable bag.

Oh, and we were on a scooter.

So naturally, I asked for a bag. And right there, in the middle of the checkout, she started to lecture me on waste and what we “could” use that money for. I remember thinking really hard about all the ways that I could spend a nickel and not coming up with many, but I wasn’t about to bring that up in the checkout line. So, because I love her, we stuffed a fair number of vegetables, crackers, and maybe even a small bottle of milk into our pockets and her purse, got on our scooter, and off we went.

At that time we did not own a single property, we were both working very hard, and hadn’t even talked about kids. So later when I got up some courage to bring up the “bag”, she reminded me that every nickel we don’t spend is one nickel closer to all the things we really wanted in life. A home, marriage, kids, and the financial security we wanted to achieve. Don’t get me wrong, you can get married and have kids for $0, but we wanted to have a certain level of security before we went down that road. First and foremost, a home.

I had a degree in economics and had done my fair share of reading and calculations on opportunity costs, but this was the first time I remember actually equating it to my life so directly. To me, the bag was a bag. It cost such an insignificant amount of money, why would I even think twice? To Mrs. Sloth, that bag was a step backward, no matter how small, in our journey towards building a life together. Thinking of it that way, no wonder she was pissed 🙂

One more story / example before I get into the calculations of the whole thing. So I used to smoke and drink. Pack a day and a beer or glass of wine a night. Plus weekends. I won’t pretend for a second that I quit these things because of money. When my first child was born, I remember having a cigarette and just thinking, I don’t want to do this in front of him. And once going out or god forbid a hangover starting taking away time with him, I knew it just wasn’t for me anymore. Again, to stem any nastiness, this is MY choice and I have done plenty enough to never point fingers or judge anyone. My point with this, is that once I gave up these things, I noticed a HUGE amount of extra money. Full disclosure, I did pick up a pretty serious cheese habit after this, but you get what I’m saying.

So now that I have bored everyone with stories from my past, what does it mean, financially, to have vices, or indiscriminately spend little amounts of money? As with most things financial, it is compound interest that makes the difference.

So let’s look at a pretty typical one for a lot of us. Beer.

Screen Shot 2018-03-31 at 2.11.54 PM
CHART 1-Source: Bustle, Investopedia

 

Ok. To walk you through the chart. The item is the expense in question. The source of the info is linked in the caption. Frequency is how many times the expense is used per day, week, month, or year. Cost / use is how much it costs to use the item for one frequency. Interest rate is the average return of the S&P 500 since 1928.

So $1,200 bucks a year seems like a decent amount. That is a new laptop (MacBook Air 13″ 256GB – $1,199) That’s after 1 year. If you were to squirrel that away in an S&P index fund for 10 years, thats $2,360.58. At a 10% downpayment, this is 10% of getting into a new home. (average home in 2017 is ~$200,000 and average downpayment is 10%) After 20 years, this is $4,643.62. That is almost half of in-state tuition for a public university!

All of that, just for not drinking beer FOR ONE YEAR! This doesn’t assume that you quit drinking beer forever. You could take a year break, save the money, buy an index fund, then continue to drink for the next 19 years and receive the same result! Now, look at what happens if you quit drinking beer for the entire 20 years and save $1,200 a year for 20 years and invest it in the market.

Screen Shot 2018-03-31 at 2.47.15 PM
CHART 2-Source: Bustle, Investopedia

Screen Shot 2018-03-31 at 2.51.31 PM

Do the math for yourself. That’s the beauty of compound interest. $53,838.21.

Now, for those that are more technically inclined, these prices for goods are not adjusted for inflation, but if we assume a similar inflation rate for the expense and the benefit good (computer, home, tuition), then it becomes a wash if we keep saving at this rate over the full period. Yes, if we just save for one year and then go back to buying beer, the purchasing power of your saved $1,200 will be less than in chart 1, but still… it’s free money peeps.

So how about that cup-o-joe habit you got?

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CHART 3 – Source: Huffington Post

After 20 years, thats a respectable college fund.

We could argue for days about the future return of the S&P or whether college tuition will increase at ever increasing rates or any of the details, but the fundamentals remain the same.

All those daily expenses cost you something. In fact they cost you a lot.

Now here is the part where I walk back a lot of this:

We all get enjoyment out of the little things we spend money on. I have a $10 a week cheese habit. I am eating a cookie right now that is completely unnecessary, but absolutely delicious. My point is that, if we take a look at all of those little things and cut out one or two, we can be that much closer to financial independence.

And what about my plastic bags?

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CHART 4 – Conserving Now

So… as always, Mrs. Sloth was correct.

It is always possible that my math is totally wrong and feel free to check me whenever you feel like it. If anyone wants a blank copy of the .xls sheet I have made to throw in their own numbers, let me know in the comments and I’ll send you a file.

Thanks for reading and see everyone next week for a new post! If you enjoy Financial Sloth, please Like, Comment, and Share!

FS

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