Understand the Opportunity Cost of Money

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The Opportunity Cost of Money

There is an Opportunity Cost Associated With Each Dollar You Spend

Opportunity cost is defined as the cost of pursuing one alternative versus another. For example, if you were going to spend $500 on a new bike, the opportunity cost would be that you would not be able to buy anything else with or invest that $500. For the purposes of financial planning, you should look at the cost versus the benefit of each decision you make. In this case, you could spend $500 on the bike or you could invest the same $500 in a savings account. In five years, the bike will be worth $25 and the $500 investment will be worth $650 (including interest). The opportunity cost of buying a bike is the long-term benefit that you will receive if you did not buy the bike and invested it. Technically, the opportunity cost is not limited to the cost of investing the money, but also includes any other opportunity you could spend the money on (investing, buying something else, saving the money, etc). By carefully evaluating your alternatives and by weighing the opportunity cost of each decision, you can vastly increase your long-term wealth.

The next rule is to understand the time value of money.