Managing Opportunity Costs

There is a tragic flaw in decision making. Every decision you make automatically precludes others you could have made instead. The potential attached to those other decisions is called “opportunity cost.”

Opportunity cost is what you give up to do the thing you do.

The danger in avoiding the analysis.

Let’s suppose you inherited a summer home on a lake. Does that make it free? Of course not. There is still maintenance, municipal taxes, insurance, hydro, and the price of the toys you’ll need to make full use of it. In many cases, people find acquiring the property is the cheap part.

When you look only at the cost in step 1 – the acquisition, you frequently find later that the ongoing costs harm you. A useful question to ask yourself before you acquire anything, is “Okay, then what?” Many affordable things will suddenly become unaffordable. Governments often miss the full analysis of this step and end up with a host of secondary effects for their trouble.

Assessing the choices

There is always another way to proceed. The “Do Nothing” choice is omnipresent, and it can be analyzed in the same way as the “Do Something” choices.

Making valid decisions involves knowing some things about you. The thing you want to do matters and the way to do it is a secondary consideration. Know your purpose, your resources, your timeline, and your priorities vis a vis other things you must do. The result of this will be the answer to “Why” you chose the method you did.

When you know your why, the fact that other options might have turned out better doesn’t matter so much. You made the best decision you could make in your particular circumstances when you made the decision.

You will analyze your choices before you decide, and you will know the costs and benefits of each choice. You will know the cost to make your decision in two ways.

  1. How many resources were required to make it work?
  2. How many resources were required to make each of the others work?

You will know why you chose one over the other. It is because the ratio of benefit to cost in the present is greatest for you. Some other choices might have a higher benefit but at a greater cost. When you analyze later, your why will help you understand how you gave up the possibly much larger benefit of some choice you didn’t make.

Can you manage it?

Many people cannot handle that late-appearing conflict. If they had done the analysis a little better initially, they would know how their actual answer came to be, and they can accept it. That also helps keep them from jumping from one solution to another. Flexibility is important, but only if applied wisely.

Wise people can relate to their decisions in the context of the situation when they made them. Looking back is interesting, but an ineffective way to judge. If you know why you made a decision, you can win in two ways:

  1. You will be comfortable with the decision despite something else having been better.
  2. You will learn from your mistakes and make better decisions in future.

An example

Ron Wayne was the third founder of Apple. He owned 10% of the company and did the non-computer stuff. The manuals, the business, and the marketing. He had previous business experience and was the only one of the three who had any money. He also found “the Steves” to be a challenge. As the company grew, he realized he was risking his entire wealth if anything bad happened. It was a partnership at the time, and each partner is responsible for all the debts. Rather than risk what he had as the business tried to compete with huge and well-established business, he decided to sell his share. He did, and he did so for $2,300.

Possibly, a mistake. But he never regretted it. His view was, at the time, it was the right thing to do. He was able to understand that because he knew the why—a wise man.

The Takeaway

No matter what you do, you cannot know exactly how the future will play out. Do your best with what you have to work with right now.

I help people have more income and larger, more liquid estates.

Call or email or in Canada 705-927-4770

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