Opportunity Cost

Yesterday I wrote about the chance of having two car payments if you trade in a car that still has payments remaining. I noted that as long as you had a paid off car and paid cash for your new purchase you were ok.

I was reminded by my friend Living Almost Large that just because you have cash in hand doesn't always mean you can afford or should be making a car purchase. Or any purchase for that matter.

It all boils down to opportunity costs.

Opportunity costs you say. What exactly is an opportunity cost and why is it so important?

Opportunity cost is generally a business or economics term. Technically, opportunity costs are choices that yield often completely different results. It's the use of scarce resources wisely. And it's not always cash as it could include time, enjoyment and pleasure. A company for example may have to decide to build a plant addition or invest that money in the marketing of existing products. They may need to decide whether to expand overseas or further develop here in the states.

For us regular folks, LAL was pointing out that there may be a more enjoyable, pleasurable or simply better use of the cash other than spending it on an automobile.

And frankly, LAL is correct. Is it best to spend the money on a vehicle or would it be better to invest it for a long period of time and enjoy the fruits of it's earnings at a later date?

It becomes often a matter of understanding the need for gratification and when it's best to delay it.

As Dave Ramsey tells us, a spoiled child cannot wait for gratification and must have their gratification need immediately fulfilled. A mature adult knows when it's time for gratification and when it's time to delay gratification for the greater good.

In many ways, using cash instead of other means of monetary exchange often helps us decide the opportunity cost of a decision. It's always harder to part with dollar bills versus using a credit or debit card. We realize the stack of money bills in our hand or wallet will be less, much less, if we spend them on something in the present. That's another prime example of opportunity cost.

Enjoyment and pleasure also are an opportunity cost offset often by work and the earnings the work can bring.

As with all things, balance and moderation must come into play.

If we choose to work as much as possible, the opportunity cost is lost relationships and often poor health. In this situation, we need to balance the need for income and the largest wealth building tool most of us will ever have with the relationships we have with friends, nieghbors, spouses and children. All suffer if we work too much.

We will also suffer if we spend to much time with them and don't work at our career and nourish it through continuing education. We no longer can afford to do things and care for those important to us if we allow ourselves to become work obsolete as well as not being accountable to an employer if employed or customers if self employed.

Understanding the opportunity cost of life choices will be a challenge as long as we live.