What Are Opportunity Costs?
If you're not familiar with the term "opportunity cost," then shame on our public educational system. Why? Because a keen understanding and awareness of that term are critical to the amount of financial happiness you will experience in your lifetime.
If you don't know what they are, opportunity costs are the values of what you give up by choosing one course of action over all other alternative actions and can be tangible, intangible, or both. Let's first discuss the tangible opportunity-cost of debt.
Tangible Opportunity Costs of Buying on Credit
First of all, if you decide to spend a given amount of money on a non-appreciating good or service, you are simultaneously giving up the right to spend that specific allotment of money on anything else that money could have purchased. For example, you could have used that money to:
- Take time off from work.
- Purchase something else of equal or lesser value.
- Purchase an investment.
- And so on.
In the case of choosing to spend the money rather than invest it, the tangible opportunity cost would be equal to the amount of interest you could have earned on that money if you invested it for a designated period of time (less than or equal to the remainder of your life, or that of your heirs). In the case of large-ticket purchases, the opportunity cost of lost interest earnings can be staggering!
Now, if it turns out you don't have the cash to purchase a product or service you desire, then, of course, you can choose to buy the product or service on credit. If that's the case, then not only are you giving up the right to earn interest on the money used to purchase the product or service, but you are also giving up the right to earn interest on the interest charges you will now be forced to pay rather than invest. Now, did your lending institution ever bring that fact to your attention? Of course not.
Intangible Opportunity Costs of Buying on Credit
In the course of borrowing money for non-essential, non-appreciating products and services, other opportunity costs arise that cannot be quantified -- and therefore cannot be used to calculate the cost of debt. Here are a few of the most common intangible opportunity costs of buying on credit.
Inefficient Decision Making:
Having easy access to credit gives you the false impression that you can have it all. As a result, you're not likely to take the time to determine which basket of products and services will bring you the greatest emotional returns.
If you were forced to pay cash for everything you purchase you would instantly begin getting higher emotional returns from the same amount of money being spent.
Deficient Problem Solving:
Since it's much quicker and easier to solve a problem by throwing borrowed money at it, having easy access to credit tends to thwart our natural problem-solving abilities.
If you were forced to pay cash for everything you purchased you would be amazed at the number of problems you could solve with little or no expenditure of money (decreased opportunity costs).
Crystal Ball Predictions:
When you buy on credit, you are basing your decision on how much money you are earning now, and on how much you enjoy your present work. However, because you cannot know what the future holds, for all you know, you might be repaying the debt on half the income you are making now after being forced to work at a job you hate.
If you knew now that halfway through your debt repayment you would lose your job and would be forced to dig trenches by hand in 110-degree heat -- for half what you are earning now -- would you still decide to create this debt?