Everyone has a price. At work the other day, we were playing the “what if” game, after a particularly horrifying happening on Fear Factor. It was along the lines of “Would you ever cheat on your spouse?” “No? But what if Bradley Cooper was on your bed naked?”.
We established that everyone has a price. Everyone has a limit of how much self control, resistance, or willpower they have before the rewards for the action opposite outweighs the rewards for the desired action.
This applies to your finances, as well, and this is why personal finance is so very personal.
An example I have exhibited recently is with my car. I wanted to save; my intentions where to bring my net worth up by a substantial amount in 2012. I also wanted to go on a trip and be able to buy a new couch. My “price” was the prospect of having no car.
In simpler terms, I was excited and more than able to save for all of those things I listed above, but I wasn’t willing if it meant having no car. I obliterated my plans to reach those goals by taking on new debt, because for me, the opportunity cost of having a car outweighed the opportunity cost of buying those things and increasing my net worth.
Where this really gets people in trouble, is if their opportunity cost for material things or spending frivolously is higher than their opportunity cost for paying bills and being financially responsible.
In simpler terms, people get in trouble when their opportunity cost for the “wants” outweigh their opportunity cost for the “needs”.
Sure, paying for food and hot water, health and shelter, those aren’t fun things to have to pay for. I’d, too, rather spend my money on trips to Mexico and a cute dress from my favorite store.
But will I do that at the cost of my ability to pay for my means of getting to work?
If debt wasn’t an option, we’d really be able to see where our opportunity costs lie. If I wasn’t able to take on the car loan, would I have spent my entire income on a car, or would I have realized I couldn’t afford to do that and moved closer to work and school?
If debt wasn’t an option, would some of the people that Gail Vaz Oxlade helps on ‘Till Debt Do Us Part let their homes foreclose to pay for their boats and lattes, or would they cut those out of their daily spending diets?
Where do your opportunity costs lie? What are you willing to forgo for your lattes, your iPad, and your Manolos?
Before sinking yourself into more debt by purchasing that dress in the boutique below your office, think about this “If I didn’t have a credit card, what would I be not paying for to buy this dress?” If the answer is nothing, because you have more than enough cash in your account for the dress, your bills, and your savings, great.
If the answer is security, or the contribution to your emergency fund, you should be weighing the opportunity cost between your financial security and the amazing pattern of that adorable dress.
What if the answer is your RRSP or Roth IRA contribution? Are you willing to forgo your future stability for a dress you’ll grow tired of in six months?
Weigh your opportunity costs as if debt wasn’t an option. It's hard to do, because debt is an option for most of us, but it really helps put some things into perspective.