Lesson 6 Opportunity Cost and Benefits of Good Financial Decision Making

Opportunity Costs

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One of the most powerful concepts in personal finance is an understanding of opportunity costs. Simply put, every time you make a purchase, you’re giving up something else you could have done with that money.

For example, when you buy that new shirt, you’re not just spending money, you’re passing up the chance to use that cash in other ways. You could have treated yourself to a movie, grabbed a pizza, or filled your gas tank. Or you could have put that money into savings.

Opportunity Cost and Spending Habits

By recognizing the opportunity cost of each purchase, you may rethink your spending habits.

Let’s take a closer look at how this plays out in real life. Imagine someone buys a soda every day for $1.25. Over the year, they spend $456.25 on sodas. That’s money they
could have spent elsewhere or even saved and invested. Here’s where it gets interesting: if you saved just $100 a month starting at age 16 and earned a 12% return on your money, by age 56, you could have over $1 million in the bank.

Before making any purchase or deciding to save your money, it’s helpful to take a step back and think things through. Consider your options, weigh the opportunity costs, and make choices that align with your long-term financial goals. By doing this, you can make more informed decisions that will set you up for a brighter financial future.

Making Good Financial Decisions

Good financial decisions don’t happen by accident. The decision-making process starts with identifying the problem, gathering information, considering your options, and weighing the pros and cons. Once you’ve done that, it’s time to make a choice and put your plan into action. Afterward, evaluate the outcome to see if it worked or if you need to change course.

Before making a purchase, we must think about what’s driving us to buy. Are we truly fulfilling a need, or are we indulging a want? Do we spend money in reaction to stress or sadness? The decision-making process should involve evaluating not just the item but also the advantages and disadvantages of our choices.

Defining Needs and Wants for Better Planning

Understanding whether something is a need or a want is essential in building a solid financial plan. Ask yourself: Is this something I need or is it a desire? If you can avoid buying something just because it’s a “want,” you can use that money for your financial goals.

Before making a purchase, consider these decision-making questions:

Will I still be happy with this purchase in two months?

The excitement of buying something new can quickly fade, leaving you with an item you no longer use—and if you put it on credit, you might still be paying for it long after the thrill has worn off.

Another helpful tactic is to put unnecessary purchases on a "30-day list." If you still want an item after 30 days, it's not an impulse buy. But the odds are, you'll forget about most items on the list well before the 30 days is up.

This mindset can help you avoid impulse buys not in your best financial interest.

How to Make Smarter Choices

In personal finance, good decision-making is key. We often assume that people make choices in a rational, logical step-by-step way, weighing all factors before deciding, but many people make financial decisions based more on emotion than on logic. Money is inherently emotional, and making financial decisions based on emotion can be especially damaging. Recognizing this and taking a step back can help prevent such decisions.

Before making a significant purchase, for example, identify whether it's a need or a want. If it's a want, what is driving it? Are you trying to "keep up with the Joneses?" Do you have FOMO? What is the opportunity cost of spending this money? Will this purchase detract from an important financial goal?

Even though this process might seem detailed, if you can make this decision-making process a habit, especially for big-ticket purchases, you'll improve your ability to make smarter choices in the long run. Over time, these small, thoughtful decisions will add up to better financial outcomes.

Understanding financial decision-making can help shift the way you think about money. While money itself may not guarantee happiness, having financial security and freedom certainly makes life smoother. Smart financial choices give you the freedom and flexibility to pursue your goals, allowing you to enjoy what you want without the stress of how you'll pay for it. When you're in control of your finances, you’re better equipped to achieve your desires confidently and without the constant worry of bills piling up.

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