There’s a gremlin nibbling away at your wealth as fast you can accumulate it. It’s a real threat operating under a rather benign-sounding name, “opportunity cost.”
Opportunity cost is a financial principle that is critical to understanding how to build and preserve wealth. Yet, most people fail to grasp its’ importance for their financial futures. Opportunity cost is the idea that each dollar spent is a dollar lost forever. Once you spend money, you permanently lose your ability to invest it in something else or pay off debt. If you want to tip the financial scales in your favor, you must understand how to calculate the actual cost of every daily, weekly, and monthly expenditure you make. For example, say you spend $50 a week going out to eat with friends. Does your meal cost just $50, or is it much, much more? If you took that same $50 and invested it in a vehicle that gives you a 7% compounded rate, you’d have over $37,000 accumulated in ten years. You could use this money to pay down your debts, make a down payment on a cash-flowing asset, or put into your retirement account.
The Rule of “752”
Financial educator and pundit David Bach coined the term “Latte Factor” to describe the many ways in which Americans tend to fritter away our cash. Bach gave us a more formal description of the Latte Factor in his “Rule of 752.” According to Bach, if you multiply a habitual purchase by 752, the product will be the amount of money you’d have in ten years had you invested that money wisely. Bach used an 8% rate of return for his Rule of 752. However, even using half that rate, you can see that money spent on things you don’t truly need or want can add up quickly, causing pain and frustration when you are ready to retire. While the Rule of 752 isn’t as hard and fast as the Law of Gravity, it is a useful tool for motivating yourself into more mindful spending.
The Small Things Count
Seldom is money success or failure incumbent upon one cataclysmic event, such as losing money in the stock market. Instead, success or failure is the result of numerous actions done (or not done) over many years. It’s easy to fall into a pattern of spending on things you don’t really need or seldom use in our transaction-focused world. This careless spending is the “death of a thousand cuts” to our wealth.
When you make unnecessary purchases or overpay for things instead of shopping for bargains, it adds up. Lattes and other unnecessary expenditures can come back to haunt us as we prepare for the time when we no longer get a paycheck. The key to avoiding making habitual money mistakes lies in becoming more aware of each dollar you spend.
