Opportunity cost is the benefit of what an individual misses out on when they spend their funds on a particular item vs another item or investing it. Several excellent examples include Term Life Insurance versus Whole Life Insurance. That article will highlight some examples of how Opportunity Costs may seem small today but add up to a significant number in future years.
The Latte Factor, car purchases, and now, new to everyone’s spending options… Streaming services are all examples of things we can spend money on, and then we lose the opportunity to use that money toward our goals.
The Latte Factor
This is a concept created by author and financial expert David Bach. In his quest to help people with their finances, his goal was to help them start by making small changes to their budget, which, over time, impact their net worth. In principle, the Latte Factor is instead of spending $5 a day on coffee from a coffee shop, which we all know sometimes leads to an added pastry because… “I deserve it,” take the money you would have spent and start putting that towards your retirement. Your $5 a day turns into $150 a month, equating to spending approximately $1,800 a year for coffee… not including any pastry or tips!
If you start at 0 and put $150 a month into an investment earning 7% from age 25-65, that would be almost $400,000. We like to say, “Save a little until you can save a lot,” and this proves that to be true. Save $5 a day, and it will make a difference!
Buy what car?
In a more extreme situation, we can look at Dave Ramsey’s go-to example with Car payments. At the time of this article, the average car loan payment in America for used cars is $528 a month. Again, in a simple compound interest calculator, over the course of a person’s working career from 25 years old to 65 years old, if a person would have invested that $528 a month, they would have approximately $1,393,985 using the recommended 7% rate of return. Now, let’s use the market average over the last 30 years of 9.6%, which would have led to approximately $2,981,787!!! Again… This is the average car payment for a USED car! As Dave says… “I HOPE YOU LIKE THE CAR!!!”
In the new technology age, there are a lot of easy and convenient ways for Americans to make poor financial decisions. We are a society incredibly proud we “CUT CABLE” only to now have five different streaming services! We’re just replacing one expensive way to watch television for another. According to a Forbes survey, 86% of Americans have more than one streaming service, with the average person spending approximately $39 a month for their services. This adds up to $124,879 across a person’s working lifetime.
Overall, we can go on and on with different examples of how we spend money and how we could make it work “better” for us. We eventually get to the extreme, where Dave talks about making fun of those who collect lint and only come out of their caves on coupon Tuesday. However, the important lesson is that we should change our way of thinking! If you are someone who is struggling to achieve your financial goals including paying off debt and starting to save for retirement, consider trying some of these small changes and you might be surprised by the impact they can make!
Our financial coach discusses opportunity costs during many of her meetings, and a lot comes down to creating new habits. If you would like to talk to our financial coach about learning habits to make lifestyle changes, or if you have questions or concerns about saving for retirement, reach out to one of our financial advisors today!