Opportunity Knocks!

This is the first in what will probably become an ongoing series of very basic and loose guides to Economics theories, concepts and terms.

 

I’ve never studied Economics, and am only just starting to learn more “formalised” concepts at the ripe old age of 36.

 

As I go about my learning, I’ll be writing these pieces as a reminder for myself – consider them my course notes.

 

Today’s Lesson

 So let’s get going! Today, and for no particular reason, I’m starting with Opportunity Cost. This is a phrase you will see littered around personal finance and investing blogs, but what does it mean?

 

Even if you’ve never heard the term before, I guarantee that you know what it is. Almost every one of us is weighing up Opportunity Costs all the time. I mean, several times a day, every single day of our lives.

 

Definition

Let’s start with a definition, from Wikipedia:

 

“.. the value of the best alternative forgone, in a situation in which a choice needs to be made between several mutually exclusive alternatives given limited resources. Assuming the best choice is made, it is the “cost” incurred by not enjoying the benefit that would be had by taking the second best choice available.”

 

Hmmm. I don’t know about you, but I find that a bit hard to get my head around, at least until I’ve read it a couple of times. Let’s see if we can put that a bit differently.

 

In A Nutshell

  •  Decisions that we make involve either time or money (or often, both time and money)
  • For every use we can put to each pound coin that we possess, there are many other options available to us for that pound coin
  • Or, for every minute of our day we spend doing one particular task, there are many, many other tasks we could be doing instead
  • Those other options that we had? Each one represents an Opportunity Cost, because in not choosing them, you’re missing out

 

Example

You buy a new bike. The bike costs £500. In addition, every year you will spend £50 on maintenance.

 

Now, you had plenty of other options for that initial £500. You could have put it in a bank account and received, say, 5% interest from the bank. The £500 would be “earning” £25 a year. That’s an Opportunity Cost, because you didn’t put that money in the bank, you spent it on a bike – so you’re missing out on an “income” of £25 a year.

 

Add that £25/year that the bank would have “rewarded” you with, to the £50 a year you’re also now spending on bike maintenance, and you’re effectively £75 a year down on your money because of buying the bike.

 

(As a good trainee economist, hopefully you went through a thought process along these lines before splashing the cash on the new wheels, even if you weren’t aware of the name for what you were considering: The “Opportunity Cost”)

 

Taking it a bit further though, maybe you plan on riding the bike to work 3 days a week instead of using the car, and thus you worked out that you’ll save £15 a week in petrol and maintenance costs by doing this? In a 47 week working year, that’s £705 a year that you’ll be saving on petrol. So even after accounting for the missed bank interest and the bike maintenance costs, now the investment in the bike is returning more than the first alternative that we’ve considered.

 

Let’s take it a bit further.. in riding the bike to work 3 days a week, you’re improving your overall health and getting fitter. This should hopefully pay long-term dividends in that you probably now have a lower chance of suffering from obesity, and maybe you’ve reduced the chances of suffering something like a serious heart problem in later life too. So now, buying the bike also becomes a good punt on reducing health care costs (not to mention the time off the road!) and maybe even buying you more life-time further down the line.

 

On the other hand, you’re chances of getting knocked off a bike are now infinitely greater than they were previously, so maybe you need to take that into consideration too…

 

 

Don’t Let It Get You Down

By now we’re seeing that this thought process could go on and on, and it’s a reason why some people can find the idea of Opportunity Cost rather depressing! Most of us are afraid of making the “wrong decision” or even just a “bad decision”, where actually, often the worst thing you can do is not making a decision at all. (Incidentally, my philsophy is that, generally speaking, there are no “right decsisons” and “wrong decisions”, but that’s for another day.)

 

An alternative to over-extrapolating the thought process of considering Opportunity Cost is just to follow Danny Wallace and become a Yes Man, but conventional wisdom would probably suggest that the best solution for most of us lies somewhere in between the two extremes. With the bike example then, maybe the process would go something like this:

 

  • Realise that you want the bike
  • Decide if you can afford it (and I mean without borrowing dosh)
  • Think about how much you’ll use it, if there’s another use for the money that you consider a more-preferred option at this time, and if it’s “worth the money” (that’s quite difficult to do, assessing the value of something – I’ll no doubt write about it later on in this series)
  • Make an informed decision and get on with life

 

Time Is Money

Like I said, we’re all doing this, all the time. That’s because there’s an Opportunity Cost to the things that we do, including those that don’t necessarily involve money.

 

Whenever you do “a thing” there are plenty of other “things” that you could be doing instead. You just spent 5 minutes reading this blog. Maybe you could have spent that 5 minutes doing star jumps, or making a sandwich, or making love (twice), or ringing the gas company about that funny smell, or reading someone else’s blog. You did none of those things – unless you’re making love whilst reading this, in which case, I salute you, and I somewhat pity your partner(s) – and so there’s a “cost” involved with that spent time (and if you should really have been ringing the gas company, let’s hope you’re not about to pay the ultimate Opportunity Cost).

 

So when people use an over-worked phrase like “That’s an hour of my life I’ll never get back!” what they are really saying (whether they know it or not) is that they are considering the Opportunity Cost. They are saying “Oh, the things I could have been doing in that time!” [1]

 

Enough For Now

Right, that’s it for Lesson One, thanks for your time. The sun’s back out, time to get out on that bike! [2]

 

JAL

 

 

 

 

 


[1] More often than not, I hear this phrase used in an office environment, and usually when people come out of a meeting. In which case, the list of alternative options for their time probably extends to “Checking Facebook 27 times” or “Fetching a round of coffees and having a bleat about the roadworks/the spouse/the PM/the state of English sport”.

What these people are usually forgetting is that they work for The Man, and if The Man says you go to the meeting, well, sadly, most people go.

 


[2]  I should probably fess up at this point that, coincidentally, I’ve just bought a new bike 😉

As a quick justification to my more frugal side:

  • I considered the Opportunity Cost – and I probably hung around a bit too far on the non-Danny Wallace end of the scale
  • My previous bike was way past its best, was becoming downright dangerous, and I didn’t consider it worth fixing up. I ride a bike instead of using any fossil-fuelled vehicle wherever possible
  • I waited and waited for what I would consider a real bargain to present itself
  • And I’m considering calling the new bike L’Oreal, because I’m worth it

 

Justification over.

 

Verti-GoPro goes loco, doh

Responsible for – amongst other things –  all manner of funny “sports fail” videos, potentially assisting people with insurance claims, helping to catch thieves, allowing us mere mortals some mouth-watering first person perspectives of what it might be like for elite extreme-sports men and woman (and/or nutters) strutting their stuff right in the sweet spot, and one of the most gorgeous videos I’ve ever seen, sports and leisure camera maker GoPro went public last week with a $24-a-piece IPO.

 

Falling into the infinitesimally small group of companies that I feel I actually “sort-of” understand – I know what their products are, what they do, who uses them etc. – I almost considered trying to get hold of some of these shares. However, I resisted because of one of the many reasons why I have steered clear of buying individual shares in any company thus far;

I have no idea what their “business model” is, what their accounts look like etc. and I’m not the sort of person (yet) that has the time or desire to look into it too much and try to make a call on whether I consider them “investable”.

 

It’s fair to say then, if I were to buy shares in any given company, it wouldn’t be the most well-informed decision, given my uber-lazy attitude in this respect. It could be said that it would be “a bit of a gamble”, and gambling is not high up on JAL’s “how to get rich” guide.

 

So, I stuck to my conservative guns, left all my investment dough in the confines of my warm, fuzzy passive index trackers, and let GoPro go pro without me. And what did I notice last night? In their first 4 days of existence on the NASDAQ, their stock pretty much doubled in price.

 

Whilst my initial reaction was obviously “Oh f***! If only I’d listened to my instincts and taken that punt…!”, at least I have re-affirmed something in my mind – even though occasionally I think I’m just starting to get a grip on the absolute basics of how “the stock market” works, it is still an entirely unpredictable place that scares the living crap out of me.

 

Maybe I’m wrong though? Maybe someone can explain this behaviour that we’ve witnessed in the first few days of GoPro’s IPO? If so, please let me know! Although I guess if anyone really did understand it, then they’d have also seen it coming, and thus have probably retired to their private island by now. In which case, don’t forget to send us a link to your GoPro scuba diving video 😉

 

JAL

Introduction to.. Wealth

Well, after being paid the ultimate compliment this week – Mrs Just About Life read the blog (I didn’t ask her to) and sent me an unexpected and wonderful message at work to say how much she loved it – I’m stoked and back as promised with the next of the “mini-series” of articles on the three main themes of this blog.

“Money can’t buy me love” sang the Beatles (they obviously never played Amsterdam). It can buy you all sorts of crap though, or it could be used to get you out of your boring job earlier than expected.

Yep, today we’re talking about a big, ugly subject: Wealth.

money-case-163495_1280

Since Mrs JAL liked the 2-step plan from the Introduction to.. Health so much, I’m going to repeat the trick for Wealth, here it comes.

Wealth – the 2-step plan

  1.  Spend less than you earn
  2.  Invest the rest (wisely)

 

Got that? Sounds simple doesn’t it? And that’s because it is.

If you follow Step 1 and Spend less than you earn, then you will have some left every month.

Which means you can get stuck in to Step 2 and Invest the rest (wisely, of course).

So what does that mean? As with last time, let’s now go into a bit of detail.

 

1. Spend less than you earnscales

Exactly what it says. Every time you get paid, that’s all your money until the next time you get paid. Don’t spend it all. Simple.

 

But plenty of people don’t do this. Many people just spend without really thinking about it. Some months they get lucky and might not spend what they’ve earned, and some months they definitely do spend more. Over the months and years, things might even just about balance out, but one thing is for sure – those people won’t be getting rich any time soon. (Some people even consistently spend more than they earn, and get into debt. This is a horrible place to be, and something I might look at in a future post.)

 

So, what can you do to consistently achieve this goal of spending less than you earn? I’m glad you asked. For a start, you could consider making a household budgetI know, I know.. But stay with me! The JAL family started doing this last November, and since then we feel a lot happier, far more in control, and – dare I say it – it’s actually fun and enjoyable to be prepared, to really think about your spending, and to keep track of what’s going on. Not to mention the tremendous feeling at the end of every month when we review and realise we’ve hit our targets again, bringing us one step closer to our goal of financial independence. Yep, budgeting can give you the laser focus that can really ramp up your efforts and get you to financial independence much quicker.

More on budgets in an article soon, because they’re really important! See? I put it in bold and with an exclamation mark to prove just how important they are. But for now you can stop sweating, that’s all on budgets. For now.

 

Next, you have to change attitudes. Again, in bold.  Because attitude is everything. Our society seems to have developed this “I deserve it” mentality – “Hey you! Yes, you there in the smart suit! You’re working hard every day, so you deserve those shoes, that new leather-trimmed executive car, AND that holiday to Barbados!”

And you probably do deserve those things! If that’s what you really want..

But looking at this another way – you buy the shoes, the car, and the holiday now, and you’re effectively robbing your future self. And your future self might not be happy about that. So, how’s about not blowing every last penny every month, and when you’re 60* you’ll be able to stop work, go to Barbados for 2 years if you want, and wear new shoes every night. (Ok, maybe not, but hopefully you get my point. And anyway, by the time you get to 60 I reckon you’ll realise that the shoes don’t make you that happy anyway, and that there’s a lot to be said for walking around barefoot – especially on the beaches of Barbados)

 

 


2. Invest the rest (wisely)money_increase

Ok, so you’ve made a budget (or maybe you haven’t… yet) and you’ve got that “bit” of money left over every month, remember? Well, I guess you have several options for what to do with it. For example, you could:

 

  1. Go shopping and blow it all on designer gear and expensive coffees, or
  2. Buy a new flat/round/curvy/voluptuous/whatever television, or
  3. Invest it (in about a million different ways)

 

Now, I know that plenty of people will see options 1 and 2 as infinitely more exciting than option 3. But I can tell you that if you choose one of the first two options, you won’t be financially independent any time soon. Like, not in the next 40 years. If you take the 3rd option – and you regularly take the 3rd option (as in “EVERY month” regular) – then you WILL GET RICH. You will get rich slowly, but you WILL GET RICHRemember – it’s all about attitudes. Change your attitude, change your life.

 

A reminder here that none of this is financial advice – and the usual disclaimers apply – but as an example of what you could do with your leftover dosh each month, you could probably do worse than opening a stocks and shares ISA with an online platform (investing through an ISA takes advantage of some tax benefits) and setting up a monthly direct debit to invest a regular sum into a low-cost index tracker fund. Let this direct debit carry on automatically and forget about it.

 

 

Pay it forward

You could even really commit to this and pay yourself first. Set up your direct debit into your investment account for the next day after your monthly pay day. This way you always get paid. Hopefully, your investments will – over time – just grow and grow, until one day you can just not go into the office any more. Wahey! (How to work out when this day might come? Check back for future articles, I’ve got some ideas on this one and maybe even some useful tools for you!)
Control yourselfkeys

The most important thing we’re talking about here is taking control. By budgeting, and socking some dosh away on a regular basis, you’re taking control. You can’t control the stock market, or the housing market, or the job market, or any other market for that matter.. But you CAN control how much YOU SPEND and therefore how much YOU SAVE. And the fact is that people who do this have a much, much, much better chance of achieving their financial goals.

What the Dickens?


So, as a final note then, how does wealth relate to happiness? This is obviously a subject for much debate – money is an extremely emotive subject, and I look forward to writing plenty more about this. But since we’re looking for simple, straight-talking views, look no further than the advice of Charles Dickens, who sent this message to the Victorians of 19th century England via the character Wilkins Micawber** in “David Copperfield“:

Annual income twenty pounds,

Annual expenditure nineteen pounds nineteen and six,

Result happiness.

 

Annual income twenty pounds,

Annual expenditure twenty pounds nought and six,

Result misery.

 

That sounds a lot like “Spend Less Than You Earn” to me…

Cheers Wilko me ole mucker, sound advice!

 

Until next time – pay yourself first!

JAL

 

 

 

 

 

* Obviously if you’re aged 58 and reading this, this may not quite be true

 

** Interesting “back story” on the character of Wilkins Micawber, from Wikipedia, he was:

..modelled on Dickens’s own father, John Dickens, who like Micawber was incarcerated in debtors’ prison (the King’s Bench Prison) after failing to meet his creditors’ demands.

..(later) Micawber is hired as a clerk by the scheming Uriah Heep, who assumes wrongly that Micawber’s debts arise from dishonesty. But working for Heep allows Micawber to expose his boss as a forger and a cheat. To start anew, Micawber and his family emigrate to Australia with Daniel Peggotty and Little Em’ly, where Micawber becomes manager of the Port Middlebay Bank and a successful government magistrate.
 

DISCLAIMER

I am not a financial expert. I do not work in the financial industry. Nothing on this blog is intended or can be considered to be financial advice, and I cannot accept responsibility for any of your actions. Always do your own research, or seek the help of a professional, and make your own decisions. I am merely expressing an opinion here, based on my own experience.