“The price of anything is the amount of life you exchange for it.”
– Henry David Thoreau
Many people categorize me as an extremely frugal person; Fortunately I am Dutch, so it is expected of me to be cheap and it does not bother me. I work hard for my money and as long as you still sell your time to an employer it means you literally exchange hours of your life for it. Money is a valuable commodity. It is even more valuable when you understand the time value of money, or opportunity cost. In fact, for most millionaires and billionaires their lifes are based on opportunity cost.
The time value of money
To explore the concept, let’s illustrate a story about a janitor working for a small, local supermarket. He is not very bright and cannot move up the corporate ladder even if he would try, he does know, however, about opportunity cost and the time value of money. His goal in life is to provide a financially stable future for his kids. At 18 years old, he start to work for his local supermarket – scrubbing floors and cleaning spills – and since he has an excellent work ethic, he continues working at the same place for 65 years. During his time working for the local supplier of fruit, meat and vegetables he manages to save 50 dollars a month for his entire career – or 600 dollars annually – and invests the money in the stock market. His invested money grows at an average rate of 8%. At 83 years old, his back is aching, his knees crumble and he stops working. His net worth is now 1,197,016.76 and the business empire he has collected over his lifetime is now capable of providing almost 5,000 dollars a month for his kids, without them ever having to work for a penny of it during their lifetimes. Instead of starting to save money at 18 years old, he could have bought a premium television subscription for 50 dollars a month (which he does not really need) and he would not be able to save the money for the future of his kids. The total lifetime cost of this television subscription is not 39,000 (50 dollars times 12 months times 65 years) but is a grand total of 1,158,016 dollar and the peace of mind that his kids will be financially supported for the rest of their lifes, an enormous utility difference compared to being able to watch a different sports channel every evening.
So when I am thinking about a selling or buying decision, I not only think about the present value, but also the future value and potential utility the decision costs. It means walking past Starbucks and seeing not a 5 dollar coffee on the menu, but a 750 dollar coffee. Someone would have to be really god damn thirsty to buy a 750 dollar coffee, but if you take a quick peek at the Starbucks annual results it proves that people do this every day.
Money is worthless
While I am writing this, in my mind I can already hear people complaining: “Why would I suspend paying for a coffee now? I don’t need 750 euro in the future, I need a coffee. Now!”. The answer to this really depends on the future and present utility of the money. Money by itself is worthless. It merely exists to provide for utility by exchanging it for goods, experiences and options. For someone on the road to financial freedom, it provides the option to stop having to sell time for money. The utility that a high yielding dividend stock provides is time to spent as you please. For someone who does not mind getting up at 8 for the rest of his life to pay for coffee, the utility of the future money – and thus the opportunity cost – is much lower.
Note that opportunity cost applies to every decision in life, not just financial decisions. If you decide to take a stroll through your local park, you can not also stay home and read a book during that time. Another example; a man plans to become a billionaire so he can buy a yacht and travel around the world with his wife. He works, and works, and works to achieve his vision. In the meantime – because he is never home – his wife leaves him and he is left alone with a useless yacht. Ignoring the opportunity cost of his behavior was an error in selective perception.
So does this mean a person should save all his money and live like a sewer rat for 20 years to become rich? Perhaps it does, it depends entirely on the person making the decision and the standard of life they need to have to be happy. Would he be content to live in the gutter during this 20 years, with the promise of riches in the future or would he be miserable for 20 years? The opportunity cost in the second situation would be too extreme to justify; He might become terminally ill after 19 years and he will have ruined his life for nothing and he would have been better off enjoying his life in the first place.
Experiences are priceless
For myself, this continuous balancing act between present and future value usually results in me being extremely frugal when it concerns buying objects – a new TV, new shoes, a big house – and actually spending a lot of money on experiences. In fact, I would invest a considerable amount of money in a fantastical wedding and honeymoon, because I know it would be a once-in-a-lifetime core memory that will stay with me and my partner forever. If that money was spend on buying a nice car, it would have been almost entirely wasted in comparison.