The Opportunity Cost Fallacy
The Opportunity Cost Fallacy
I have written before about how the financial independence community can be somewhat close minded. This is no more apparent than when discussing luxury spending. Post in a local forum or on Facebook about a big purchase, and the dissenting opinions come quickly. Over and over again, the claim is that by spending on these big-ticket items, we lose out on the opportunity cost. Whenever I talk about stealth wealth fails, I always get this argument tossed back at me with a great deal of vehemence. Yet, I believe these arguments are spurious. Many fall prey to the opportunity cost fallacy.
The definition of opportunity cost per Investopedia:
Opportunity cost is the cost of choosing one alternative over another and missing the benefit offered by the forgone opportunity, investing or otherwise. Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made. This cost is, therefore, most relevant for two mutually exclusive events. In investing, it is the difference in return between a chosen investment and one that is necessarily passed up.
Real World Example
In reality, the conversation looks something like this:
Post on Facebook:
Me: Hey guys, I bought a new Tesla (Picture of me waving with a brand new car).
Naysayer: Such a waste of money!
Me: Why? I love the car!
Naysayer: Opportunity costs, dummy. If you took that same 80K and instead of buying a car, invested in VTSAX, you would have a billion dollars in twenty years (Ok, a little exaggerated).
Me: Damn, why did I buy the car! I could have been a billionaire.
And this all makes perfect sense if you ignore the opportunity cost fallacy.
What, you ask, is the opportunity cost fallacy?
In short, it’s mistaking the value of money (compounded or not) above that which you have traded it for (car, vacation, insert whatever luxury here).
Let’s dive a little deeper.
The Cost of Experience
A repeated theme in the opportunity cost fallacy is that we lose the opportunity to let our money grow and compound. In my humble opinion, however, it is short-sighted to believe that the trade off is always worthwhile. For instance, certain experiences occur only once in a life time and are well worth spending on.
At the beginning of our careers, my sister and her husband moved to Australia for a year for a temporary job relocation. Burdened by our busy careers and leftover college debt, my wife and I decided to forego the costly trip and save instead.
Years later, I have huge regrets about not taking the trip. Of course, the thousands of dollars that we didn’t spend may be tens of thousands of dollars now. But I will never have a chance again to go stay with my sister and see the awe and beauty of their temporary home.
Certainly I can afford to go now, but I can never go back and rewrite myself into their youthful adventure.
The Value of Things
You know what’s really exciting about FIRE and fatFIRE. You have enough money. Technically, once your investments and side hustles cover your yearly expenses, everything left over is just gravy. So there comes a point when spending a few thousand here or there (or a few hundred thousand if you’re lucky) just doesn’t move the needle.
As many have said before, it serves no one to be the richest couple in the graveyard. Herein lies the crux of the opportunity cost fallacy.
On the other hand, that beautiful painting that hangs in your room, or that speedy car in your driveway, may actually move the needle quite a bit. It may give you pleasure for years or even decades.
The Future Is Not Assured
While it is financially responsible to plan for the future and cover a hopefully long and healthy retirement, the opposite is also very possible. Sadly, people sometimes die young.
It would be very sad to die at a young age after spurning the pleasures of material wealth and foregoing the joys that money can buy.
No one knows when your time is up. It is OK to spend money, to live a little.
In Conclusion
Don’t fall victim to the opportunity cost fallacy. Every dollar earmarked for spending could, in theory, compound and bring you more wealth. Yet, as human beings, we need to eat, breath, and shelter.
We also need to covet, and adventure, and experience the best money can buy. Sometimes.
There is no shame in trading wealth for enjoyment and memories.
Money was meant to be spent.
Always so good! Just got my daily dose of awesomeness…. i honestly fall in the same boat of thinking as you do on this. When i first started pursuing FI it was about cutting out every expense, and squeezing out value out of every single dollar LOL. With a 7-10 year trajectory, i quickly realized this was no way to live.
In the last year or so, i’ve focused on really increasing our income, loosening up the belt a little bit, and thinking more long term. My goal is no longer just to hit FI, i want to build real wealth, and have an impact on the lives of others, not just my own.
My BHAG (big hairy audacious goal), would be to give away a million dollars. Keep in mind, as i sit here writing this, i have absolutely no idea how i’d be able to make that happen. However i do think it is possible, and also if i can somehow pull it off before i die, i think it would be a very fulfilling accomplishment.
Thanks Half Life! The FI intention changes over time. If we are lucky, we loosen up the purse strings a little and relax.
That’s why I spend $44,000 to climb a mountain in Antarctica 😉 And once you reach a certain net worth like you have, there’s no such thing as an opportunity missed by not purchasing something and investing. You’ve already won the game and gone well past the goal post!
That sounded like a helluva trip!
Everyone is quick to pull out opportunity cost as their favorite business term but usually never hear about substitution, price elasticity etc.
I’m not sure how an index fund is an appropriate substitute for a car or a latte but sure I guess they made the math works.
I’m a believer in saving and avoiding overindulgence but at some point if our only goal is to save it for retirement we are spending 80% of effort for 20% of our lives.
I agree, when saving becomes the point, wealth re missing the point!
If we always think of opportunity cost then technically we would never buy a thing. That huge pile of money then goes to heirs that likely never learned the value of money and they wealth is lost by the 2nd and almost definitely by the 3rd generation. Why would I sacrifice so much to never enjoy it and only pass it down to heirs that likely have an entitled complex. That’s why people are shocked that ultra wealthy people like Bill Gates only plan on leaving small percentage of fortune to kids (still a lot of money but nothing like the billions they are worth)
I struggle with legacy. How much should we leave our kids?
Paula Pant’s theme “you can Afford Anything, you just can’t afford everything” comes to mind. It’s all about our choices. Your example about not visiting your sister in Australia is that type of thing we look back on with the realization of regret. The regrets we have are usually missing experiences. But still, it’s tough to choose, because FOMO is sometimes just following EVERY experience.
Yes, I thought of Paula’s intro when I wrote this. Great minds think alike!
Na I like my honda
All of this goes back to how much is enough. One way I analyzed my pile, was to look at the unmolested end of life portfolio value which I estimated at $16M. If I subtracted nothing that was the size of the mountain mountain. I then analyzed the end of life cost of living. For my lifestyle it is $5.5M leaving me with an estimated $10.5M in the bank at my demise. I essentially have saved for 3 retirements. If I spend a couple hundred K on a Tesla or two over the years, I die with 2 retirements (10M) still in the bank. If I buy a $2M yacht that’s another story. The overhead of a $2M yacht is not trivial. I analyze it this way because this is how professional money managers analyze it.
I think you should buy a few teslas. Drive a different one each day.
It’s all about spending intelligently. What do you value? Spend on that then opportunity cost doesn’t matter.
It’s the whole valuist idea. I agree.
I think a lot of people who talk to you about opportunity cost are really just wishing they could afford to do what you are doing. It’s also good to note many people actually can’t afford the item talked about. They would have to borrow the money. They didn’t have the money for the alternate opportunity, so it wasn’t lost.
Dr. Cory S. Fawcett
Prescription for Financial Success
Those of us who have accrued a decent amount did so at the cost of scarifice. I believe that we bought the right to spend how we please.
Dog G, this is exactly what I need to hear. I have been going crazy with investing and saving every dollar since I was introduced to the FI Community 4 months ago. I just realized that I need to smell the roses along the way. Life is not a hundred meter dash…….
Very true. Balance enjoyment of the here and now with the future.
For all of you out there that are saving like mad. What are you saving for? When will it be OK to spend it? Somewhere along the way you must stop saving and start living/spending. Or maybe the answer is to have fun all along the path to FI. Balance is the key.
Dr. Cory S. Fawcett
Prescription for Financial Success
Well said. Either way works with balance!
Money is meant to be spent. Yes. This. I also read this somewhere a while ago and it really changed my outlook on money. Money is meant to be spent.
That means if you don’t spend it in your lifetime, someone else will be spending it.
I try to spend some everyday.
If you don’t fly first class, your son-in-law will.
Dr. Cory S. Fawcett
Prescription for Financial Success
Oh goodness. That opportunity cost statement drives me mildly apoplectic. You are not a spreadsheet. You use spreadsheets to assist with certain math magic. But really none of us live our lives as a spreadsheet. Life rarely works out as all those calculations predict.
I live almost the same now as when I had much less. Everyone figure it out for themselves and all the noise shall melt away.
Buy whatever the heck you like if you can afford it and want it. It’s really that simple.
We wouldn’t want you apoplectic! For many of us FI people, the life style creep really isn’t that significant.
An excellent read. I do not deny that sometimes I do “fall prey” to this fallacy myself. That is a delicate balance between “saving up and investing it wisely” vs “splurging on experience and stuff” that we really want.
At the end of the day, that’s your money and no one else can judge you. Spend it wisely yes, but at the same time, spend it without regrets 🙂
Trying to live without regrets is a big part of this lifestyle. People do judge us on purchases though. Not only in this community but in real life when they see what you have bought.
Just mention in the same post that you are out of the accumulation phase. That should clear up any misunderstandings. Most in the FI community have not reached the goal yet, so for them bying a Tesla would indeed be dumb.
While logic dictates what you say to be the best path, often I see negativity spewed at people for spending regardless of what stage they are in.