For the past several years, I have constantly repeated the importance of looking at your opportunity cost when determining how much money you should be investing or saving. From time to time, I've provided real examples to help you understand what that means and how I use it in my own life as a way to determine the trade-off between investing for tomorrow and enjoying my money today. Yesterday evening, I found myself in a situation that might prove illustrative to those of you who are still working to understand how to think about the true value of your capital.
Opportunity Cost Is the Benefits You Won't Be Able to Enjoy as a Result of Your Selection
As has been well documented on my personal blog, I've been renovating my house over the past three months. My attention is now focused on the master bedroom suite, where I wanted a good, quality furniture manufacturer that was still reasonable given the opportunity cost of my money. Since I am only 29 years old, every $1 invested is worth somewhere between $142 and $1,433 by the time I am Warren Buffett's age, to provide a popular metric a la the world's most famous investor.
That means if I spend $1, I am not spending $1. My opportunity cost is much higher. I am spending all of the future wealth that my dollar would have become for my family, heirs, and charitable foundation; all of the dividends, interest, and rents I could have generated. Thinking about opportunity cost that way gives me a lot of clarity into the question of what matters to me; what values I hold most dear. You don't waste a lot of money on meaningless materialistic things unless they add utility to your life if you take this approach.
When I redesigned the bedroom, I was caught between a love and appreciation for really nice things (think Henkel Harris or Baker furniture) and saving-as-much-money-as-possible-to-invest (think Sauder pressboard furniture sold at a discount store). These two conflicting values mean that a choice must be made about what I value most. There is no right or wrong answer, it is whatever I want to live with in terms of consequences and foregone outcomes. Do I want to give up the pleasure and utility of nice furniture or the enjoyment of a higher net worth figure?
Looking at Expenditures Through the Window of Opportunity Cost
After a lot of debate, and letting myself think about it for a few months, I decided the best course of action would be a reasonable compromise. I allowed myself a few of the "wish list" pieces from the Rolls Royce of furniture brands; firms such as Councill. For most of the main furniture, I worked with a design consultant and narrowed my options to a handful of furniture brands that had high quality construction (e.g., dovetailed joints, wood-on-wood sliders, etc.), including Bernhardt, Thomasville, Stanley, Hancock & Moore, Lexington, Ralph Lauren, and a few others. Different bedroom sets were designed in each and then I decided, without looking at the price, which one I liked the best. The result? The Stanley City Club won by a landslide.
The Total Compounded Future Value Wealth Given Up Is Between $2.3 Million and $24.1 Million
Adding up the pieces of the Stanley City Club bedroom set, I bought a bed, two marble-topped bachelor's chests, a dressing chest, a drawer chest, and a leather-tufted end-of-bed bench. The package retailed for $12,300 but my favorite furniture store got me down to $7,342 after taxes and delivery.
By the time I'm done, the bedroom itself is going to cost me $30,000 retail. Being a good shopper, and knowing how to access certain wholesale lines, I was able to negotiate that to around $16,800 discounted-after-taxes-and-shipping. In economic terms, it means that I get the utility of a $30,000 bedroom set, but the cost to me was not the $16,800 check I had to write but, instead, somewhere between $2,385,600 and $24,074,400 in future wealth that I would have had if I live to be Warren Buffett's age.
As I looked at the paperwork, the question I asked myself was, "Is giving up $2,385,600 to $24,074,400 in future wealth by the time I am 81 years old worth having a redesigned bedroom, factoring in the probabilistic outcome that I may, or may not, reach that age?" In other words, I was trying to make a conscious choice about what I valued more so that I could live in a way that maximizes my own personal happiness. This is what I mean when I say that money is a tool. You cannot make money, by itself, your only goal. Unless it is converted into utility for you, in one form or another, it is worthless.
Given my opportunity cost, I decided it was better to have the bedroom set, luxury carpets, nice mattress, cashmere blankets, and custom window treatments today than more money in the future. That was based upon my own, personal opportunity cost because I already have plenty of capital working for me in private businesses, retirement accounts, and brokerage accounts. Everyone has a different opportunity cost. I wouldn't have done this when I was 18 years old; it would have been a mistake back then compared to my opportunity cost today.
The Moral of the Story - How to Use Opportunity Cost In Your Own Life
The moral? Go through life calculating your own opportunity cost. If you are thinking about spending money on a new car, ask yourself if you are really willing to live with the consequences; the "true" cost. If you are, God bless! Enjoy it. If you aren't, don't buy the car. It is a foolish decision to go through life without thinking. Your money, and job, are only tools to increase your personal happiness. You will be amazed how many things you reject that people say you should want, and how many things you buy that seem completely ridiculous, if you start using this structure for making decisions about how to spend money. You'll also be amazed at how much happier it can make you in the long-run.
Remember: A dollar is never a dollar.
