Want to see how that $5 coffee you just bought could instead be a vacation or a down payment for a car? It only requires a simple change of perspective to view regular expenses differently. Sticking to a budget is difficult, but this strategy will help you shift your mindset about spending money in general.
Learn how to achieve your financial goals by adjusting your view of small expenses.
What Is Opportunity Cost
The idea that this strategy is based on is called opportunity cost. It is the concept that by choosing one cost you are giving up another. Each choice has an opportunity cost. In economics, it compares the cost of one item to another of the same monetary value. For example, if you spend $300 on a television, what is the next best alternative for that $300? That alternative, such as a night at a nice hotel, is sacrificed by purchasing the television. However, the way we use opportunity cost is very different because it has the ability to shift your perspective about spending over the long term.
How To Shift Your Perspective of Money
Let’s start small. In our first example, we compared a $5 cup of coffee to a vacation or a down payment for a car or any other big purchase. Now we know that sounds crazy – there’s probably not that many things you can think of for $5 that are better than your daily coffee. But, stick with us and you’ll understand why it’s actually not crazy at all.
The first and most important step is to stop seeing that cup of coffee as being only $5. This is harder than it seems because as humans we tend to think of things in the short-term. However, once you take a step back and look at the bigger picture, you’ll see that this daily cup of coffee is actually costing you $1,300 a year! That’s simply a $5 coffee x 5 coffees a week x 52 weeks in a year. Now, the next thing to think about is what you might be able to do with $1,300.
Once you’ve thought of something, such as going on a vacation, you will realize that the opportunity cost of getting coffee everyday isn’t just saving $5, but is actually foregoing a nice vacation! The whole trick here is to change the way you see and associate monetary value. Now with that $1,300 there are endless alternatives, such as a $1,300 down payment, a small home project or really anything you can possibly imagine for $1,300. Perhaps instead of dropping the coffee habit altogether you buy an inexpensive coffee maker and brew yourself a cup each day, which is an adjustment but it’s doable. With this approach, let’s say you spend $300 in total for the coffee maker and coffee for the year – now you are saving $1,000 to put toward the next best opportunity.
Obviously not everyone buys a coffee or tea at a premium every day, but you can use your imagination to come up with a small cost on a regular basis that you don’t think twice about. This can even be eating out for lunch a few times a week or going out for dinner once a week. Let’s say either of those options cost $50 each week. Over the course of a year, that’s $2,600 that you can put toward something else. Now you can see how small purchases add up to significant ones over a year. Again, there will be some small portion of that $2,600 that you will need to use to make lunches or dinner at home, but hopefully you get the idea.
Learn about different types of bank accounts to find the right one for your lifestyle to help you reach your financial goals.
How We Use Opportunity Cost To Make Spending Decisions
In general, we do our very best to avoid small purchases like daily coffees or lunches out. We make lunches and most dinners at home and shop at discount grocery stores to get the most bang for our buck. Because most of our costs are on a monthly basis, like internet, mortgage and insurance, we use opportunity cost from an even longer term perspective.
We have never paid for cable because the cost doesn’t outweigh the benefits for us – cable can be really expensive. So we pay for internet service on a monthly basis and for a few months we tried Hulu. The premium plan is $11.99 a month. Like the coffee, this doesn’t sound like a lot. In fact, for a year it’s only about $144. So we like to think about our financial goals and try to put costs that might not seem like a lot in a year on the same terms.
For instance, a 10 year goal of ours is to save enough money to buy land in another state. That $1,440 we could have spent on Hulu over the course of 10 years could be better spent on a small portion of the land we’ll purchase. Therefore, we don’t see the situation as spending or saving $11.99 from Hulu. We see it as either we decide to have Hulu or instead decide to have land in another state.
Not only does this help us with our budget but it also helps us achieve our goals easier since we are chasing a concrete objective of buying land and not simply chasing an obscure objective of saving some vague amount of money simply for the sake of saving it.
Our Challenge To You
The next time you are about to buy something – small or large – consider what you just read. Try to change your mindset from “I want a coffee this morning,” to “What is the next best alternative for this coffee over the course of a year or several years?” Think about your financial goals and try to put expenses in the same time frame as your goals.
This simple trick of applying the opportunity cost of something for a longer period can truly change your money mindset and your spending habits. It won’t be easy in the beginning, but if you’re able to keep it in mind then it can become a very beneficial habit in the long run to help you achieve your financial goals.
Bonus
If you’re serious about using this technique (and you probably are if you read all the way to this point) then consider putting a sticker or taping a small piece of paper in your wallet that says, “next best alternative?” This won’t help you for recurring costs, like subscription services, but it could help you keep this strategy top of mind so that you are able to make that thought process into a habit.
While you’re thinking about your financial goals, you may find that you need to save up a lot of money to reach some of them. This can be intimidating, but it is simple if you break it down into steps. Read our article, How To Make A Savings Plan For A Big Purchase.
Financial freedom begins with good habits.
Rebecca & Tiago, theloadedpig.com