I just bought a new wool sweater, replacing my beloved sweater of many years that our dog decided to shred and ingest. It was a purchase just over $100, and it’s typical of the kind of discretionary expense I might make each month. Is it worth it?
Let’s look at that discretionary purchase we’re about to make. What’s the opportunity cost?
For each of us, the answer depends in large part on our top goals. Maybe we want to retire? Or go on vacation? Or get out of debt? Or free up time? Or leave a legacy? Pick one that matches your top goal, and we can look at that $100 purchase through the opportunity cost lens.
I want to retire
If your goal is to boost your retirement account, this purchase has two impacts. First, it increases the burn rate of your current standard of living. Our standard of living is easy to boost, but it’s hard to reduce. Assuming this expense is similar to others you’ll want to make going forward, you’re going to need a larger retirement account to sustain this level of spending.
If you’re spending an extra $100 a month, or $1,200 a year for this kind of purchase, you’ll need 25 times that amount in your retirement to support a safe withdrawal rate of 4%. That means you should boost your retirement account target by $30,000 (or reduce your retirement target if you’re not making this regular purchase).
In addition, this $100 a month, or $1,200 this year, could be directly deposited into this retirement account where it would grow. Look ahead 25 years, and this year’s purchases would accumulate to $6,513 if you were lucky and earned a 7% return, after inflation, in your retirement account.
So in summary, this spending habit requires an extra $30,000 of retirement, and it means you’re also several thousand dollars short in your retirement account versus pursuing your goal and depositing it now into your account. Play out different scenarios with this simple spreadsheet.
I want to take a vacation
This one’s easy. The $100 this month, or $1,200 this year could buy you a week in this bungalow in Tahiti with $600 leftover for an airplane ticket. Which is more important to you?
I want to get out of debt
If you have credit card or consumer debt, this purchase is a choice not to pay down that debt. Let’s assume it’s a monthly purchase, so it’s $1,200 this year. We don’t get around to paying off this year’s debt for five years, and we have a typical 16% interest rate on our credit card. In five years it is a $2,520 debt.
Time is our enemy with consumer debt. Wait 10 years and this will double. Wait 25 years and it will grow to just under $500,000.
Here’s a handy spreadsheet that allows you to play with some different scenarios. It’s easy to see why households with credit card debt can find themselves on a downward spiral. Consumer debt is insidious.
I want my time back
They say time is money, and it’s true. If you’re making $25 per hour, this purchase is a half day’s work each month. Worth it?
I want to help others
There are so many ways to give. In one example, a $65 donation to UNICEF can support 15 malnourished children with lifesaving nutrition for five days. Or put differently, the $100 purchase this month, or $1,200 this year, is enough to provide a year’s worth of meals to three children all year in a famine-plagued country.
Closer to home, and near our Tiller headquarters outside Seattle, a $1,200 gift to United Way of King County helps buy a year’s worth of educational books and toys for five low-income families.
It’s your money
Should you buy it? There is not a right answer. In fact, all of these are worthy goals.
In my case, I decided to buy the sweater. It replaces one I wore every week, and I know it will get tons of mileage. I’ll also say that by simply writing this blog, I’m thinking more about the opportunity cost of that next $100.
What is your #1 goal? Keep it in mind when you’re making that discretionary purchase. Is it worth the opportunity cost of not making progress towards YOUR #1 goal? Money matters because life matters more. Make sure your money is supporting YOUR goals.