Opportunity Cost
What is opportunity cost and why MUST you learn it and apply it to your finances?
What is opportunity cost and why MUST you learn it and apply it to your finances?
Opportunity cost helps you decide where your money should go to best service your particular situation. Here is an example. What should you do with an extra $200 per month?
Should you save it? Should you invest it? Should you pay down debt? Should you hit the mall? The casino? How you answer this question and ultimately do, will tell us plenty about what your future life will look like.
The mall and the casino should be off the table if you have debt or if you have no debt, but your emergency savings needs more funds or your retirement plan needs more investments. That is a no-brainer for those who are thinking about their future. Now, let’s get to the more difficult issue. Do you pay down debt or save/invest the money?
Look at the interest on the debt. Let’s say it is 5%. Opportunity cost requires us to consider what that money would do for us if we put it on the debt (earning a guaranteed 5%) or somewhere else, like a retirement account where we could earn beyond 5% or in a bank account earning .02%.
The numbers tell the tale. Get the 5% instead of putting the extra money in the bank at .02%. Investing the money could be the solution if you focus on no-load index stock mutual funds that could earn 7% or more.
The issue there is, do you know how to get that kind of return after cost? If so, consider that option. If not, put the money down on the debt and start reading What Color is the Sky. Opportunity cost should be weighed with every decision you make. Make the right one!