Opportunity Cost

Every once in a while I will indulge and buy things that I really want.  However, every time I purchase something I always take into account the opportunity cost of buying it.  How do you know if buying a Mercedes S600 is worth the extra price to you personally over a Buick Lucerne? 

A brand new Mercedes S600 has an MSRP of nearly $160,000.  A brand new Buick Lucerne has an MSRP of roughly $35,000.  So what is the opportunity cost?  If you bought the Buick you would have $125,000 left over to invest, and thus if you assume an 8% return, by the time I am 65 (41 years) the $125,000 would have grown to be $3,712,938.66.  So ask yourself, if you were choosing between the two cars which would you get?  Personally, I would go with the Buick because the saved money has an enormous future value to me.  If I were 45 or 50 years old, then I would most certainly get the Mercedes because I have less time to invest the saved money, and I would probably have a much higher net worth later on in life. 

Another very simple way to look at this is to ask this question.  If you were a 24 year old like myself making this decision, and I told you I would pay you $3,712,938.66 on your 65th birthday if you chose the Buick…would you do it?  This turns the tables on the perspective a little bit and most people find this one easier to think about.  This same question can be asked for any purchase.  If I paid you X amount, would you choose this or this? 

The decision between the two cars is not trifle.  The opportunity cost is enough for most married couples to retire on very comfortably.  Imagine being able to retire comfortably, or pay for your kid’s education, or donate to your favorite charity, or drive a Ferrari, or own a mansion, or … the list goes on…just because you made a very savvy financial decision at one point in your life.  $3.7 million is not quite enough for me to retire on.  I really do want to be able to have the luxury of traveling the world and staying at the nicest hotels the world has to offer when I retire.  I want to have great food at restaurants around the world, and I want the freedom to have control over my own time in life.  I will get to this point by making “smart” financial decisions throughout my life.  I say “smart” because it only applies to the goals I have.  If you don’t need or want what I do, then you may want to spend more money in the present if you gain more utility from it.  Like I have said before, what you do with your money is highly personal and depends on your goals.  I just happen to love the challenge of accumulating wealth. 

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