The Power of Opportunity Cost & Why You Should Use It

Writing this article has been on my task list for over three months. I chose to do many other things instead of writing it. I will come back to this at the end…

What on earth is opportunity cost?

Opportunity cost can be defined as:

The value of what you have to give up in order to get what you want.

Another way to say this is that opportunity cost represents the benefits you give up in choosing one option over another option.

It can be difficult to identify opportunity costs when the benefits of the alternative choices aren’t easily measurable. Fortunately, some alternative choices are easily measurable. Let me give you a couple of examples.

Smart Phone

I first encountered the concept of opportunity cost in economics. It is rather easy to see when you put it in terms of money. If I spend $1,000 today on a new smart phone, that is $1,000 that I cannot invest in a stock mutual fund (for example). Doing a quick financial calculation, if I take that $1,000 and invest it in a mutual fund earning a 6% annual return compounding monthly, in 20 years the value will be $3,326. So the opportunity cost of purchasing the new smart phone today is $3,326 in 20 years. Of course, there is value in me having that smart phone today, so I may still choose it. I will just be better informed about the actual opportunity cost of that choice.

It’s a New Car!

One more financial example.

As a young person, I felt it necessary to always drive a nice, new car. I never had the money set aside to be able to pay cash for a nice, new car, so I financed it (aka I went into debt). This means I had a fat monthly payment to make to the lender that funded the loan on the car. The financing was typically four years. I had to make 48 monthly payments before the car was really mine. This reminds me of the old saying “I owe, I owe, so off to work I go.”

As vehicles became more and more expensive, car dealers began working with their finance arms to offer increasingly long loan payoff terms. This was to keep the monthly payments “low.” That meant that to buy a new SUV, I might be making that monthly payment for six years or even seven years.

Let’s not get too crazy with this example. I am going to use the four year loan length. Let’s say I buy an SUV for $40,000. I finance all of the price at 6% interest for four years. My monthly payment is then a whopping $939 per month! On top of that, I still have to insure it, register it, maintain it with oil and tires, repair it when it breaks down, and keep it gassed up. That is quite a commitment.

The problem with a vehicle is that it is a depreciating asset. It goes down in value with each passing day. Eventually, it will be worth nothing. How do I know this? Most of the vehicles I have purchased are now rotting in a junkyard somewhere or have been crushed into large cubes. The same can be said of the smart phone. It will eventually be worth nothing.

Thinking in terms of opportunity cost, what would that $939 per month car payment be worth if invested in a mutual fund with a 6% return compounding monthly? In four years it would be worth $50,819.

When I was buying cars this way,  there was a related problem I faced. After about four years I was ready for a new car. After all, the new car smell had long since vanished. The paint had a scratch or two. So I repeated the process. I bought into the idea that “I will always have a car payment.“

So let’s go with that logic and assume that I will continue making that $939 car payment every month for 20 years. When we do that math, at the end of 20 years I will own a fourth “new” vehicle that is worth a lot less than when I bought it. That is what a depreciating asset is after all.

If instead of purchasing vehicles this way over the 20 years I instead invested that $939 per month into a stock mutual fund with a 6% annual return, my value in 20 years would be $434,000. Guess what? I could then remove $40,000 cash from my mutual fund and pay cash for a brand new vehicle.

“Wow!” you say. “Why doesn’t everyone do it  this way?”

For several powerful reasons:

  1. To actually do it this way you have to delay gratification and possibly drive (G A S P) an old car you pay cash for. Definitely no new car smell there.
  2. To do this you have to be able to withstand the constant marketing and advertising of some of the smartest people on earth whose job it is to get you to “need” that new car smell. Think white Lexus, huge red bow on top, and snow lightly falling on you and your golden retriever.
  3. Finally, you have to overcome the peer pressure that might come from those who could look down their noses at you for driving something they view as beneath your station in life. What would the neighbors say?

Once I really learned the lesson about opportunity cost with regard to cars, I became a little obnoxious about it. In an effort to  help my kids learn the lesson, I would sometimes look at a parking lot full of expensive cars and say something like: “Look at all those beautiful depreciating assets.” They were not that amused.

One reason few of us do the opportuntiy cost calculations above is that there is indeed value in doing or enjoying something today. Driving in that new car smell, getting the latest smart phone, or having that daily cup of joe brings a certain amount of pleasure.

The concept of opportunity cost is not limited to financial matters. The reason I am a guitar plunker with a very limited skillset is because 10 years ago I prioritized other things above playing guitar. Those things may have been more important, but I still chose them over guitar. I wonder how many things we could all learn and accomplish if we didn’t binge-watch streaming entertainment? It takes a certain amount of vision to see beyond the present moment and to see what this moment could lead to if I chose a different opportunity.

In chapter 11 of my book Forward Story I write about vision: “Your mind has an amazing ability to visualize a future that has not yet occurred.Some of the greatest inventors and entrepreneurs that have ever lived had the ability to visualize their invention and how others would use it. They could see how it would make peoples’ lives better before it ever became a product. That is vision.”

You and I likewise have the ability to develop the vision to see the opportunity cost in anything we buy or in any way we spend our time and talents. We must nurture that kind of vision.

Conclusion

Back to the point I began with. Writing this post has been on my list for over three months. The reason it was not written before now is that I took the opportunity to do other things with my time. The reason it is being written now is because I chose it over all of the other things I could have done with this time. Such are the decisions we make.

My encouragement to myself and to you is to be more intentional about the opportunities we take. Pay attention to opportunity cost. Ask “Is this the best and highest use of my time, money, and talents? Ask “What am I giving up or postponing by choosing this option?”

What Retirement Means

Recently I wrote that it is time for me to re-write my Forward Story. That is because my wife and I recently achieved a major goal that we had been working on for well over a decade. With that accompished, it would be foolish to just meander without a new focus.

As I always do when I re-write my story, I start with the most distant timeframe I can envision. For me that is retirement.

The concept of retirement is a bit challenging. What does it mean to retire? We have all either known people or have heard stories of people that retired after a long employment and within a short time were either bored out of their minds or had actually passed away. Some people view retirement as a time to do nothing but relax and play.

Have you thought of what retirement means to you? I am fortunate to have many family members and friends that have already retired. By observing them I have a clear understanding of what retirement means to me. To me, retirement is simply that state of no longer needing to work for earned income. It is when passive income and/or retirement income supplies my needed standard of living. Let’s break this down:

  • Earned Income. Pretty self-explanatory, this is the most common form of income. I trade my time and talent for money. This could be hourly wages, salary, salary and commission, or contract. The biggest component of this that impacts my life is time.
  • Passive Income. This is income I receive from my investments. This can include equity appreciation through markets increasing, interest income, dividend income, etc. I get rewarded for putting my capital at risk. Very safe investments yield lower rates of return. Riskier investments typically have to pay higher rates to induce me into putting my money into them. Regardless of the actual investment vehicle and its returns, I get passive income from it. Instead of me working for my money, my money works for me.
  • Retirement Income. Increasingly rare, the company pension plan is an example of retirement income. Another example in the USA is Social Security.
  • Needed Standard of Living. Now we get a bit more complicated. I had to go and throw in the word “needed.” If I live in a tent on a friend’s property, my needed standard of living is very low relative to what it would be if I live in a four story house with a a gigantic mortgage. Of course, I get to determine my standard of living and whether I live in a tent, a four story house, or anything else. It is important to think through all of the implications of my needed standard of living vs my desired standard of living. I always need far less than I desire. You get to wrestle with all of that just like I do. As it pertains to retirement, the higher your standard of living, the more passive income you will need. This will likely delay your retirement.

Now that I have defined things, the main benefit for me once I retire will be more freedom over my time and talent. Without needing to use them for earned income, I now get to decide what is worthy of both.

Conclusion

Given this understanding of retirement, I have to calculate what that magic number is that combines both passive income and retirement income in such a way as to meet my needed standard of living. There is a lot of financial calculations and math involved in that. Nerds like me love this stuff. With all of the usual disclaimers about not knowing the future, we can then project a potential timeline for retirement.

Then I get to the more exciting part of writing the new story – envisioning the ways in which I will invest my time and talent in that new retired state. There may be some golf, tennis, and skiing in that for me, but that will be on the fringes. The retired people I know that are in their 80s and 90s are usually very active people that continue to serve and help their family, their friends, and their world. My plan will involve all of that.

What is your approach to retirement?

Time Travel in a Plague

Time travel has become an eye-rolling matter in our household. Since I first made the observation several years back that humans as a whole seem to be obsessed with time travel, it seems that at every turn there is yet another book or movie based on this concept. It’s almost like that is only trick in the storyteller’s toolbox these days. The first modern movie I personally remember that capitalized on this theme was the Back to the Future movie in 1985 that then spawned two sequels.

A quick web search of time travel books and movies reveals a huge and growing list. Do creatives just have to try their hand at some new twist on the time travel genre? I mean, I do get the fascination. How amazing would it be if there were some machine or natural device by which we could travel in time either back into the past or forward into the future? With all of the drama and intrigue of history, recent and ancient, it is tantalizing to think of dialing up a past date and location and wandering around asking modern questions and resolving mysteries. Then maybe, oh maybe, you could say or do something that might alter the course of history for the better.

Contemplating time travel – Scotland March 2019

How much money has Diana Gabaldon made with her Outlander books and TV series that are based not on time travel in a human machine but rather via mystical magical stones in Scotland? People love this stuff. I am convinced that part of the fascination is imagining how much we could accomplish in a previous era knowing what we know now. It is basically cheating. If I can know all of the questions and answers on the final exam before I take it, imagine how well I would do. Imagine how smart and powerful you would think I am. Except I’m not. I just cheated.

Even I with my time travel skepticism cannot avoid getting drawn in to the storyteller’s art as I try to make some change in the past that will improve the outcome of the future. Suspension of disbelief, indeed!

Of course, if you can time travel into the past, there is no reason that the same machine or magic should not be able to catapult you into the future. And so we spend some time there. We dial up a distant date and location and travel ahead to strange and wonderful goings-on. What is transportation like in 500 years? What about the food? Do we still have nation-states or are we one global people? For that matter, are we one Universal Empire? Oh, the possibilities!

It does strike me that one of the necessary features to all such time traveling is that we be able to return to the present. We want to tinker with the past in order to fix things so that we can get back here and finally live in a world and a life worth living. We want to visit the future but return to the present because we can’t bear to leave behind the people we care about and the culture we inhabit, regardless of how flawed it might be. We also want to bring back the technology of the future and make the world a better place. At least that is the more noble spin we would put on cheating.

If such a time machine or magical stones really existed, would you sign up to take the ride if you knew you could never return to right now? If it really were a one-way trip, would you do it? Most of us would never sign up for that. Why not?

That makes me wonder if right now is really so bad? Do we have some innate sense that we are supposed to be here now? We do travel to our pasts in memory. We even travel to far distant pasts via books and our imagination. We also travel to the future in our thoughts and via art. But we live here. Now.

Do you know how much money I could make if I knew the future? Even if I could only know one day in advance I would devise a strategy to capitalize on it. So would you. But we cannot. Despite the claims of diviners and charlatans, humans can only guess at the future based on past experience and assumptions. Sometimes those guesses come true and create the illusion of prescience. But alas, even the most skillful guesser is exposed at some point.

Is there any point to all of this? Right now we are in the midst of a frightening present. We are dealing with what future historians will likely call a plague. By every definition I have come across, COVID-19, the current Coronavirus, is a plague. We do not know how this is going to turn out. We can use modern epidemiological models to try to predict how many people will contract it and how many people will die because of it. We can try to predict how long it will take to “run its course” or how long until someone develops a vaccine. We can look to the past and make predictions based on how the Spanish Flu impacted the world, but in the end we are making predictions. This fills us with concern, uncertainty, and even fear. Our public officials, and every one of us world-wide, are being forced to make decisions without being able to see the future.

This is the way life always is. We all have a past we can draw on and learn from. We all have a future that is unknowable. But we live in the present. My resolve in this moment is to refrain from predicting the future while valuing the people in my life that matter most. I am reading and dreaming and reflecting like always. My spiritual understanding informs my ultimate cosmic hope and comfort, but this moment in time is a reminder that life is a gift best lived in the present.

Vinyl & Nostalgia

Nostalgia.

What is it?

Dictionary.com says it is

a wistful desire to return in thought or in fact to a former time in one’s life, to one’s home or homeland, or to one’s family and friends; a sentimental yearning for the happiness of a former place or time”

Nostalgia can be unhelpful, even dangerous. For example, it is not good if all you ever do is wish for the past and use that to avoid the responsibility of the present and future. That type of nostalgia is not what I have in mind.

Nostalgia can be a good thing when it reminds you of some happy or important aspect of your story. Benjamin Franklin said “Dost thou love life? Then do not squander time, for that is the stuff life is made of.” When we look back on the way things were at some earlier stage of life, we are looking back on our time and how we spent it. Hopefully we did not squander it. This type of nostalgia is a type of remembering. It can be a way of remembering important values and practices.

Most of us get nostalgic when looking at old photos or watching old family movies, but it can happen at a moment’s notice in other ways as well. One of the pleasant surprises that I have experienced over the last few years is the revelation that one of my favorite musical artists is actually the niece of one of my former high school teammates. I get some degree of satisfaction knowing that I was a fan of her music before I knew who her uncle was. The fact that her uncle is David just makes it all the more enjoyable to me.

The artist is Grammy award-winning singer-songwriter Sarah Jarosz.

A couple of years ago we attended her concert in Austin. We got to meet her and tell her of my connection with David. For some reason that night I bought her latest album in vinyl instead of CD. I cannot explain why I did that because we had not had our old turntable set up and working for over twenty-five years.

More recently it was our pleasure to meet Sarah’s parents, Gary and Mary, as well. They are lovely people enjoying their daughter’s immense talent along with the rest of us.

This past weekend I dusted off the old stereo equipment, bought some new speakers and speaker wire, and connected the turntable. The first vinyl I played? You guess it – Undercurrent, Sarah’s LP (that stands for “Long Play” for you whippersnappers) that we bought that night.

This vinyl recording is new so it is missing the signature pops and crackles of an old dusty record, but it still takes me back to the day when this was how music was enjoyed. It reminded me of Darrell Starnes and the parties at his house. It reminded me of Guy Anderson and his love for music. It reminded me of strobe lights, black lights, the robot, and the friends I grew up with at a place and time that had a lot of good things about it. It was not perfect. That is one of the dangers of nostalgia – it often conveniently glosses over and idealizes a previous era.

So it wasn’t perfect, but it was pretty good. Music was a big part of it, as it is for every generation from Big Band to Hip Hop. My friends and I were all adept at playing vinyl records, both 33 and 1/3s and 45s (look it up). My parents before me even played 78s. We all knew how to operate the equipment and where to buy the new albums.

There is something wonderful about the fact that my return to vinyl was inspired by a young artist who was not yet even born the last time my turntable was in operation. I am glad I did not toss our large vinyl collection. I am eager to break out the old stuff. To my friends from school I want to challenge you to find your old turntable and set it up. Bring out Black Sabbath, Kiss, Aerosmith (no, the old Aerosmith), Four Tops, the Eagles, and that other stuff that had your parents convinced you would never amount to anything.

Whether vinyl means anything to you or not, I want to encourage you to reflect on those good moments and people in your life and to enjoy the good things you have experienced. Perhaps consider if that simpler time has some values that you can import into your family in the present and future. If not, just smile at the good memories.

For your enjoyment here is Sarah’s “House of Mercy” video from the LP Undercurrent:

A question for you vinyl-era folks: What is the first LP you will play when you get that turntable set up?

I want to close with a disclaimer. For many people the past is not a happy repository of wonderful things to recall. For many the past is a painful reminder of tragedy, regret, and even evil. Because of this fact, I urge caution (and in many cases professional help) for delving into those types of hurts from the past.

The past is a foreign country; they do things differently there.

– L. P. Hartley, The Go-Between

The secret of leadership is simple: Do what you believe in. Paint a picture of the future. Go there. People will follow.

― Seth Godin, Tribes: We Need You to Lead Us