Hi everybody. Welcome to this edition of 5-Minute Finances. My name is Kyle Davis with Integrity Financial Group of Orlando, Florida. We are a local financial planning firm dedicated to helping our clients make smart money decisions and achieve their financial goals. Today we’re going to discuss a hidden cost on every dollar you acquire called Opportunity Cost. In the very broad sense, there are only 2 things you can do with a dollar. You can spend it or save it. Spent dollars are lost forever and you can never get them back. The potential future value of those spent dollars is called “opportunity cost”.
Example: hold out one of your hands. Every dollar that I put in your hand you can do one of two things with it. You can either spend it, or you can put it in your pocket. If you spend it, it’s gone forever and you never get it back. If you put it in your pocket, it will earn 10% interest this year. So if I give you one dollar and you choose to spend it, how much did that purchase really cost you? You not only spent the dollar, but you lost what the dollar could have earned for you had you been able to put it in your pocket. That 10% interest that you lost is the “opportunity cost”.
Let’s do some real numbers here! What is the cost of a purchase, including opportunity? Well, let’s take an expense of $10,000. If you had $10,000 but instead of spending it, you invest it at 6.00% APR compounding 10 years, you would have earned $8,194 in addition to the original sum…but remember…you didn’t invest it. You spent it. Because you spent it, you don’t get the extra $8,194 that it could have earned in interest over the 10 year period. That money that you lost out on, is opportunity cost.
We have to take opportunity cost into account for every major purchase in our lives. You have to ask yourself, what is this REALLY costing me? Because remember, you’re either earning interest on your dollar, or you give up the ability to earn interest. You must not only consider the cost of a purchase, but the opportunity cost as well.
If you have any questions on dealing with opportunity cost or if you’d like to speak personally, call or visit us online at www.financialservicesamerica.com. Thanks for reading this edition of 5-Minute Finances – Financial Wisdom in 5 Minutes or Less.