I recently sat down to review the results of the personal-finance goals I set in 2019, as well as writing new goals for 2020. One of my medium-term goals was to leave my traditional job and transition to full-time self-employment. I hadn’t planned to make the shift until late 2020, but luck and preparation collided. I was able to cross this goal off the list in September.
As a result, I sat down to update the timeline of a few of my long term goals, to move some t0 do items up on the calendar, and to shift around some priorities. It was while I was reviewing my calendar, I realized that to grow my business both in the short and long term, I need to focus my efforts on revenue-generating activities, such as finding clients. This means I need to say no to other activities that would be considered the technician aspect of my role. If you’ve read The E-Myth by Michael Gerber, this concept will sound familiar. If not, and you are an entrepreneur, I suggest you pick up the book – I own the bookkeeping version.
What Is Opportunity Cost?
Opportunity cost is the cost of giving up the opportunity to do something else. For example, I can spend an hour a week mowing my front lawn, or I can spend an hour a week working on marketing my bookkeeping practice through social media. The opportunity cost for mowing my lawn is the loss of a potential client who finds my business on Instagram.
Examples of Opportunity Cost
Another example is I can spend a few hours a week writing blog posts. The opportunity cost of those blog posts is attending networking events to raise awareness about my practice. As an alternative, I can consider hiring a VA to write those posts for me or whether a blog post adds value to my business.
Nothing is “free” and identifying where I can get the most value from my time and money by looking through the lens of opportunity cost and what I’m giving up is a critical tool to optimize my actions.
While these examples are directly related to decisions around growing my business, opportunity cost also applies to decisions in personal finance. Consider your mortgage interest.
The Opportunity Cost of Interest Payments
If I pay my mortgage off over the original 30-year term, I will pay over $300,000 in interest over the life of the mortgage. There are some clear opportunity costs of that $300k in interest payments, such as spending that money on vacations or by freeing up time to spend with my family by working less.
I don’t want to pay that much in interest, so I am focusing my efforts on paying it off over the next three years. However, there is an opportunity cost to those extra mortgage payments as well. For example, I could invest the additional money I’m paying on early principal payments int my retirement accounts. Through compound interest and the benefit of time, together with a loss in tax deductions, the value of that money may exceed the interest I’m paying.
How does opportunity cost impact your personal finances? Have you ever thought about it from this angle? Let us know in the comments.