Money Psychology

What is Opportunity Cost? (and My Opportunity Lost)

What is Opportunity Cost? (and My Opportunity Lost)

Whether you’re talking about your investments, your view on the economy, or your approach to life in general, your conclusions, actions and results usually hinge on your perspective. I’m often amazed at how different people view the same situation in very different ways. I’m even more amazed by how slight changes in how we look at things can literally change the course and quality of our lives.

Last week I promised to fill you in on what’s been happening with our life changes. (If you’re not familiar with the background story, take a look at Risk Is Relative.) We bought a home in a new city last week. We’ve spent a lot of time over the past two months looking at houses and weighing options, but this transaction happened really fast.

We were originally going to move to a very small town about 2½ hours away from here. Gradually, we came to realize that this probably wouldn’t suit us as well as we thought. We liked the idea of a simpler life, but couldn’t fathom the thought of driving 30 minutes or more to reach major shopping areas. Apparently, we’re city slickers at heart.

The home we bought is only about 2 years old. It’s pretty nice, but the truth is that we had to act on it so quickly in order to secure it that we didn’t have much time to scout out the area. We know that the city is centrally located in Ontario, so that will be great for the new business. Other than that, we’re kind of going in blind.

We don’t take possession, however, until mid-August (the closing date is actually on our 19th wedding anniversary!) so we’ll have plenty of time to investigate. Now we need to concentrate on selling our existing home.

If you have never heard term opportunity cost before, the basic idea is that anytime you choose to pursue one option, you are sacrificing another. For example, every time you choose to spend an hour working overtime or clipping coupons you are sacrificing an hour of leisure time in exchange for that financial benefit. While that is often just fine with many people, I think that many more of us simply do it because it is the normal thing to do and pursuing wealth for material benefit is what we consistently told is right and proper time after time.

Opportunity Cost

According to Wikipedia, opportunity cost is “the cost of any activity measured in terms of the best alternative forgone.” It’s a key concept in economics and investing, but it can also play an important role in just about any life decision. When we decided to move in order to have the opportunity to maximize the potential benefits of my husband’s new job, we had to weigh some pretty serious opportunity costs:

  1. Housing Cost: Our current home is located in an area where housing is relatively inexpensive, whereas our new home is in an area where housing is more costly. Our current home would probably be worth about $175,00 more if it were located in the city to which we’re moving. We love our current home, so it definitely hurts, both emotionally and financially to pay more for less in order to make this move.
  2. Emotional Cost: Because we chose every aspect of our current home and we’ve lived here longer than any place we’ve been before, it’s really hard to let go. This house is truly home. In addition, we will be leaving the city where both of our parents live. We had hoped to be close by as they age. The boys will be leaving long-time friends and starting at new schools as well.
  3. Financial Cost: As mentioned above, the new home will cost significantly more than our current home, and we will still have to finish the basement to bring it even close to our current home in terms of space and comfort. Our existing home is almost paid off, and the new home will mean that my mortgage vendetta will be extended. 🙁 This will also have implications for our budgeting and retirement planning as paying off the mortgage was going to accelerate our retirement savings significantly.

Wow. After writing that, I’m starting to wonder if we’ve made the right choice. But let’s look at the potential benefits of the move in terms of the opportunity cost of NOT moving.

Opportunity Lost

Change is at least a little scary for most people. For some – myself included – it can be downright paralyzing. I tend to play it extra-safe, but I’m married to someone who’s always pushing me to at least look at the benefits of taking the occasional leap. I’m not afraid to leap either, but I usually like to think about it a lot longer first.

My arguments for staying here are outlined above in the section on the opportunity costs of moving. However, I can also make a pretty good case for the opportunity costs of staying put:

  1. Financial Cost: If we choose to stay in our current city, the new business would be much more difficult to run. Mr. Cents is responsible for getting a new division of the company off the ground in Ontario. It’s essential that we’re more centrally located to do that. If we do this right, we could easily make this thing a huge success and benefit from the income that goes with it as well. The new mortgage could then be dispatched very quickly, and our retirement plan, turbo charged.
  2. Emotional Cost: Aside from the proximity of family and friends, we don’t exactly enjoy the city we live in right now. The new city is closer to some of the cultural and intellectual action in Ontario and we think this could be a good thing for our two musically inclined sons. There are plenty of post-secondary opportunities in the area if they choose to go that route. In addition, one of my sisters lives just a half-hour drive away, so our youngest son will get to visit with his cousins (who are closer to his age) a lot more often.
  3. Lifestyle Cost: We’ve been so preoccupied with finding a new city/house that we haven’t devoted as much time to getting the business off the ground as we’d like. Having said that, Mr. Cents is loving the work so far. This is basically the ideal job we’ve been hoping for since he left his other position in 2008. We can both work on the business, but I have the freedom to concentrate on home as well.

“Live Every Day Like…” Well… Just LIVE It!

As we jockey for promotions at work, or lust after that extra 500 square feet of house we can often lose track of the fact that there are plenty of ways and opportunities to make money, but there is only one true commodity that we cannot gain more of – time. While this sounds simplistic, it is true. I don’t really like the clichéd saying of, “Live every day like it is your last,” because it is ridiculous, but the principle is a worthy one. For example, if I literally took the phrase to heart I would spend every day going for a walk with my loved ones at a beach somewhere, in between reading books and maybe playing the odd game of basketball and occasionally asking old friends to come see me. While this sounds great in theory, I am not prepared to live in a world where everyone did this and the whole of civilization basically fell apart.

The principle of not spending huge amounts of your life doing something you hate however is a good one. The idea of getting people to examine what is truly important in their lives and then allocating their most valuable commodity – time, to them is not clichéd at all in my opinion.

Decisions, Decisions

I like to do a lot of different things in life, and I currently make a lot of decisions that revolve around sacrificing now for gains later (aka deferred and/or delayed gratification). The opportunity cost of pursuing a master’s degree is not only the money it costs, but also the time spent in class, doing assignments, and commuting. All things being equal, I would rather be having a beer with old friends, or going for a walk with loved ones somewhere, but ultimately my sacrifices as a young person are designed to get me the freedom to pursue that lifestyle sooner rather than later. Also, I enjoy challenging myself and learning new things, so while there is obviously an opportunity cost to attending classes, there are also benefits. The point is that I consciously weighed the costs and benefits before making the decision.

To Each Their Own

Working hard is not the wrong way to live, living a minimalist lifestyle and choosing not to work for extended stretches is not the wrong way to live (unless you take my money to do so). Either of these options can be the right one for you if you have weighed out the costs and benefits of it to you and your family. All I’m saying is to take a moment to re-evaluate every once in a while and decide if the goals you are pursuing are truly worth it.

So as you slave over a stack of coupons, or put in that extra weekend of overtime at a job you don’t like very much (hate is kind of overused right?) make sure and take into consideration the fact that it all costs time, and consequently it is a pretty large sacrifice indeed.

Perception is Nine Tenths of Reality

Doors are funny. Do they keep stuff out, or keep you in? Is a door an entrance or an exit? It all depends on where you’re standing and where you want to be. Do you want in or out? Perception is everything.

Obviously, we have decided, somewhat reluctantly, that we want out of our current life and are hoping that the new life we’re entering is to our liking. We understand that there are opportunity costs whether we decide to stay or go, but we’re willing to take the chance that the risks outweigh the rewards. We’re choosing to risk some opportunity costs to avoid an opportunity lost. There are no guarantees either way, but we think we can make this work for our family.

Do you weigh the opportunity costs when you’ve got a choice to make? Do you ever find that the prospect of change keeps you from making a choice?

Comments

  1. Rob Bennett

    The new mortgage could then be dispatched very quickly, and our retirement plan, turbo charged.

    This is the key, in my view. Most people are not dedicated savers. So, as income increases, spending increases.

    Those who are dedicated savers can move forward on their financial freedom goals at an amazing pace. They wait for opportunities. Then, when one comes, they don’t take partial advantage of it, they take full advantage of it.

    If you put the vast majority of income gains into savings, you could achieve financial freedom many years sooner than was earlier possible. That would open up amazing opportunities for future life growth.

    These sorts of changes happen to everyone. What’s different is that you already have a saving focus in place. It’s counter-intuitive how big a difference that can make. You need to run numbers to see it.

    I was fortunate enough to obtain a number of raises at a time in life just after I had become a confirmed saver. My wife and I saved huge amounts of money in a small amount of time. Had I not learned about saving first, we would have moved to bigger houses and more cars and more exotic vacations and all this sort of thing. Instead, we gained access to all the opportunities that follow from achieving a higher level of financial freedom.

    I don’t say that this is all going to work out right for you. It might not. I am saying that the upside potential here may be bigger than you can imagine today. When you do the pros and cons, I would suggest trying to work some numbers as to how much sooner you might be able to achieve financial independence and then think what you could do with those years.

    Your safety-first attitude is a grounding needed to make dreams real. Safety and risk are not opposites. They are two sides of a single Opportunity Coin. Being safe at the right times opens up the choice to take advantage of opportunities that otherwise would be missed. Think of it that way and things click can click together well. That’s my thought here, in any event.

    Rob

    • 2 Cents

      “Safety and risk are not opposites. They are two sides of a single Opportunity Coin.”

      I like that. If it weren’t for the increase in debt due to the change in real estate locales, this move would be a lot easier. But we’re pretty confident we can earn quite a bit more with this new business than with the old job. Maybe the new mortgage is just the incentive we need to make sure that happens! 😉

      Thanks, as always, for your thoughts Rob.

  2. My Own Advisor

    “Doors are funny. Do they keep stuff out, or keep you in?”

    Witty.

    For sure, depending on the situation, doors can be a shelter or an obstacle. Windows, geez, that’s another funny one. We want to see outside but we also want blinds or drapes on them for privacy. Go figure.

    I definitely think about the opportunity costs and losses when making any big decision. This line of thinking doesn’t always mean I’m going to make the right decision, but it certainly helps and keeps me more confident during the decision-making process. In the end, some things in life are simply worth risking. The pros and cons of today are only good for a point in time.

    Nice post, I enjoyed this one.

    BTW – I’ve moved, I finally got my own site Kim:

    http://www.myownadvisor.ca/

    Feels good 🙂 I hope you continue to stop by now and again.

    Cheers,
    Mark

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