When you spend money on non-essential, non-investment type products or services, you simultaneously give up the right to earn interest on the money you spent ... for the rest of your life. The same is true when you spend more than necessary on essential and investment-type products and services, i.e., you give up the right to earn interest on the difference.
In either case, the total of the money you spend unnecessarily, plus the forgone interest earnings, represents the real cost of spending (usually an amount much higher than is actually printed on the price-tag). Therefore, in order to make wise purchase decisions (expenditures that return a benefit of equal or greater value than their real cost), you must be aware of -- and give full consideration to -- the real cost of each purchase. This calculator will help you to do just that.
A few things to keep in mind:
- Forgone interest is compounded on a monthly basis and forgone purchases are invested at the end of each spending period.
- The stock market has averaged a return of 10% over the long run.
- If you invest your savings in paying off high interest debt, you could earn an even better return, as money you save that was spent on interest keeps saving you money on a forward basis and savings are untaxed while income is taxed.
Occasional Purchases Add Up
When you consider the financial truth that the money you choose to spend is also the money you consequently choose not to invest, it is easier to see the effective or actual cost of purchases you make that are periodic, non-essential and generally costing you more than they are worth. If you compounded all of the money that you spent on a particular unnecessary regular expense over the span of one year's time – such as buying a couple of those checkout line magazines every time you visit the grocery store – you will find that their value has much more to it than meets the eye. In order to appreciate the true cost of a non-essential purchase like that, you must first calculate what you are losing by not having the amount of purchase money invested in a high yield savings account instead. This figure in addition to the price tag on the item(s) will then serve to make up the real price you are paying for your spree.
A Moviegoers Scenario: How to Turn Your Periodic Spending Opportunity Cost Upside Down
In order to get a clearer grip on just how much financial opportunity your personal habits are costing you, we will look at the case of a frequent weekly moviegoer. Someone who treats themselves and a date to movie tickets approximately four times a month ends up spending around $100 at the theater each month (two tickets each time plus a snack). If this person has fallen into a regular habit of movie going at this rate, their expenditure on monthly movie outings alone would be $36,000 over the next 30 years. But let us suppose that instead of spending all that money supporting the film industry, they had decided to watch more movies on television, rent movies, or watch online instead and therefore invested their movie savings into an investment account at a 3% interest rate. After 30 years, this fund would be worth $22,273.69.
Effective Cost of Non-Appreciating Personal Expense
This brings the real cost of the expenditure skyrocketing all the way up to a whopping $58,273.69. This figure includes the total cost of weekly movie tickets plus the amount that the moviegoer is losing by simultaneously choosing not to invest his monies. This is the cost that must be considered by someone who is in the habit of making costly personal spending choices on a regular basis. The amount of money you are spending in addition to the amount of money that you are losing is rarely worth the small gains that you are benefiting from in your purchase, whatever it may be.
In contrast, if the moviegoer did decide that they wanted to experiment with skipping the movies in favor of a different, less expensive form of entertainment and invest their money instead, they would see significant financial results from this method after only a year or so. Naturally, the gains will build and grow on themselves over time and after a 30 year investment period you get the massive financial reward you were hoping for. This long term gain, set out in clear terms with obvious benefits, should sway most consumers to the ways of putting at least a little more thought into their periodic expenditures.