Perhaps one of the most important concepts as it relates to financial planning is one that is not often discussed: opportunity cost.
Economists will often define opportunity cost as the cost of the next best thing to your first choice. Note that the concept of opportunity cost can apply to all areas in life, whether purchases, time management, relationships, etc. Needless to say it can get extremely complicated when balancing an almost limitless array of options and short versus long term satisfaction.
To further complicate matters, it very well could be that at the cost of your first choice, you may be giving up combinations of other choices. For example, it very well could be that your first choice for any given item may beat every other item individually, but what if you were able to have options three, seven, and nine for the same cost as option one? Is option one still looking as good? For many people, option one may not be as pleasing when they begin to realize the combination of items that they may giving up.
It is this phenomenon that emphasizes the importance of carefully evaluating goals with their respective opportunity costs. Without realizing the opportunity costs it is difficult to make a good decision.
One of the most important parts of financial planning is to have the ability to weigh the projected opportunity costs and then be able to make a sounder decision. Now it is acknowledged that neither people nor markets are perfectly efficient. It is extremely easy to get lost in the moment, and short-term emotions can rob us of the long term goals that we desired when our more clear-headed minds reigned over our thoughts and wallets.
A well thought out examination of one’s goals and dreams can provide a degree of defense versus these short-term decisions by helping us realize the opportunity costs of that new automobile, the larger home in a better neighborhood, or even our dining out habits. Sharing these goals with someone else who will hold us accountable improves our chances of getting what we truly want even more.
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