Did I make the right decision?
In our day-to-day world, when we’re faced with decisions, there are two primary methods that our minds utilize to process the information to take the next steps.
The first is where situational awareness or familiarity yields a decision that is usually quick and may be associated with a habit. In medicine, we refer to these mental shortcuts as heuristics or, simply put, ‘going with your gut’ or intuition.
The second process is when faced with unfamiliar or complex situations, where a more analytical approach to try and weigh out the pros and cons tends to guide our decisions.
As you can imagine, making quick and sometimes rash decisions can lead to more errors. These quick decisions may also be influenced by unconscious bias that can lead us astray. When we spend the time to make an informed decision, we expose ourselves to new information and processing. This may delay the decision-making process and outcomes, but it can provide the necessary input to make the right decision.
A question one may ask themselves after making a decision is, “Did I make the right decisions? Or what would have been the outcome if I chose the alternative?”
Opportunity costs
As mentioned above, you consider several factors or resources when making any decision. With a finite number of resources (time and assets specifically), we can only make the decision that we feel best fit given the circumstances and the information we have.
Academics across domains observe the rationale around decisions and the opportunity cost of the alternatives. Opportunity cost is the physical, emotional, financial (any asset), and time-associated cost of a specific decision compared to the alternative options. These are calculated utilizing subjective and objective measures and can be quite complicated, but we’ll focus on measuring the objective component in today's discussion.
Let’s look at examples that highlight opportunity cost from two different viewpoints.
Q3 or Q5
Imagine you walk into a new car dealership, and they have two vehicles on the showroom floor that have caught your eye.
Car 1:
Picture Credit – www.Caranddriver.com;
Car 2:
Example credit: Gal Zauberman
Both vehicles are brand new and check all the boxes.
Great mileage, technologically advanced, can fit one or two car seats (if necessary for your life), comfort, sporty and stylish.
Now comes the time when you sit down with the sales manager and discuss the price.
On the left, the Audi Q3 is listed for (not actual numbers) $35,000; on the right, the Audi Q5 is listed for $42,000. On the surface, the cost difference may sway the decision, but what if that sales manager had another proposition? The sales manager says that if you buy the Q3, he’ll include three years of gas, complete maintenance, and washes, essentially bringing the car's value to $42,000. So, which car would you choose?
Most would pick the Q3 over the Q5 with this decision and incentives included. This is one way we look at opportunity costs. What else can I do with the money, or what could I gain/lose with this decision? Talking about gains and losses, let’s look at a more analytical view of opportunity costs.
Compound interest and compound loss
Investor A heard from a close friend that he needs to invest.
Let’s say Investor A makes $50,000 coming out of college at 22, and he worked with our financial coaches to come out of university debt-free (woo, who!!!). Now he can save for his emergency fund, then retirement, and his new future home! Let’s dig more into his baby step 4, investing 15% of his income.
To simplify the math, let’s assume there is no wage increase, and Investor A sticks to investing 15% of his income for the next eight years in the four categories we recommend (growth, growth and income, aggressive growth, and international). We’ll also apply a conservative 6% annualized growth rate, though realistically, this should be higher. By the time Investor A is 30, he would have $74,231.01, with nearly $15,000 of just growth!
www.Investor.gov/financial-tools-calculators
Then life happens. Job loss, medical emergency, family emergency, or any combination of factors that can shake the tree. In the hypothetical emergency, Investor A takes $45,000 out of his retirement account to support necessities. If the remaining $30,000 (rounded up) stays in the account for the next 35 years and grows without any future contributions, this account would equal $230,582.60! Yes, without any additional contribution!
What about the $45,000 that was taken out? This is where opportunity cost needs to be discussed. What was the opportunity cost of taking out the $45,000? A whopping $345,873.91! Instead of having $576,402.41 in the account, Investor A only has $230,582.60.
This is precisely why our team never recommends taking out of your retirement unless it is absolutely necessary to cover your four walls (shelter utilities, transportation, food). The compound interest impact on the investments and the opportunity cost are too significant.
To ice cream or not
If I waited in line at my favorite gelato place (Copa Gelato, if you’re from Columbus, OH) for over an hour because they had a sign for free gelato, could I have done something more productive with my time?
Though I may justify the time, opportunity, and wait in line for that first bite, was it really ‘free’? Our resources are finite. Time and money are two of our most important resources and directly influence our decisions. Making decisions is an amalgamation of our habitual/intuitive and rational thinking.
The question is, “How do we make good decisions?” and, more so, “How do I avoid bad decisions?” I believe having the right experiences, exposure, and teacher/mentor on your side can significantly mitigate the risk of making bad decisions. At Whitaker-Myers Wealth Managers, our team approaches every interaction with the heart of a teacher. This means we enter each conversation with kindness, empathy, and compassion, intending to build a long-term, meaningful relationship. If you’re interested in a partner to join your journey, contact one of our financial advisors and schedule some time to discuss your questions. If you’d like to submit a question for me to answer, please use this link and fill out the quick survey.
Opportunity cost: An objective valuation and impact of your decisions
March 4, 2024
Summit Puri
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