Opportunity cost is an important economic term that gets much less attention than it deserves among financial planners. It’s the idea that you have a mutually-exclusive choice to make with where you put your money. For example, you can either invest your money or spend it to buy a car. In this example, it’s either one or the other. In this case, if you choose to purchase the car with your hard-earned cash, and not invest it, then you lose the opportunity to grow potential earnings.
Warren Buffett, arguably the best investor in the world, recently did an interview where he illustrated the massive power of opportunity cost. In 1971, he made the choice to acquire a summer home by leveraging a mortgage. At the time, he could’ve easily have paid for the house with all cash. However, he knew his cash would be more productive if he placed it in Berkshire Hathaway stock. The money that he placed into this stock in 1971 totaled $150K. Today, that stock is worth $750M.
Stop and think about that for a moment.
Think about where your dollars are sitting right now. Is it at your local bank? We call assets like savings accounts, CDs, stocks, and mutual funds – “OR” assets. There is always an opportunity cost associated. With a banking policy, you have an “AND” asset. There is no opportunity cost and your money can work in two places at one time. Over a short term, this may not seem like a big deal, however, when you consider the volume of transactions we do over the course of our lives, it is a tremendous amount of wealth that we lose.
Most people don’t realize that we finance everything we purchase. We either pay interest, or we give up the opportunity to learn interest. Financial gurus would have you believe that paying cash is the best strategy, however, that’s not necessarily the case. Anytime we pay cash, we are making a decision, conscious or otherwise, to spend tomorrow’s retirement dollars today.
By taking the five minutes to read this article, you’ve made a choice that the time spent will be more value-added then using that five minutes to browse Facebook. It’s a form of opportunity cost.
Would you like to recapture lost opportunity cost and learn how to make wise financial decisions like Warren Buffett? Contact a Wealth Strategist like myself to explore what’s possible with your financial situation.