Lost Opportunity Cost. Now, this is not like saying, “-Dang it, WHERE’S MY COFFEE?!?!? Or,-“Dang it, my Starbucks coupon expired!!!!!
Still wondering? Let’s read on.
Ahh! That delicious morning cup of coffee!
One of the great pleasures of life in our world, you’ll agree. And for many of us, an essential part of our day.
–“I can’t function without my coffee!“- is a daily common phrase often heard, you will agree.
But, when budgeting for family finances and retirement as in all things, what is the true real lost opportunity cost of that daily cup of joe?
Here is an actual, true-to-life-example. Meet Ray and Liz, both 35 and new business owners. Just seven years ago, Liz underwent multiple successful surgeries to remove a malignancy that required a one-month hospital stay and one full year of physical, speech, and occupational therapy. Though in full remission by God’s Grace, she is highly concerned about protecting their cash flow, and their finances. They are currently working closely with their new financial professional to get the protection side of their long-term financial world in first order.
Like most of us, both Liz and Ray are daily coffee aficionados. Their favorite brew, you inquire? None other than a daily Grande Café latte on their way to work and on early Saturday mornings.
Wanting to be more diligent about their spending, they both do admit, however, that the $4.15 price tag before tips (please tip your barista!) for their daily java is worth the cost. Because, as Liz puts it, “-It’s not just about the coffee. It’s also the coffee experience. It’s about the community. It’s being able to take a break, relax for a few minutes, and just take it all in.”- Perfectly normal feelings, with what she has been through in life at such a young age.
Liz and Ray are not in agreement that giving up one of their daily pleasures will lead to financial independence. They do agree, however, that they are paying a dear price for not containing these costs. Having completely disregarded how much their coffee habit is costing them, has led to overspending — and, unfortunately, escalating credit card debt. Moreover, their total living expenses’ cash reserves will barely last them 2 months.
According to television celebrity and author David Bach, publisher of a new personal finance notebook, The Latte Factor: Why You Don’t Have To Be Rich To Live Rich, those daily lattes are – “-A great reason that’s keeping us Americans from saving to reach our big, lofty financial goals-“.
The Lost Opportunity Cost
One point brought to their attention by their financial professional is one of the least mentioned, most misunderstood concepts in personal finance. Known technically as the “Lost Opportunity Cost” or “LOC” for short, this is the amount of money lost or paid over someone’s lifetime. In essence, the value of that amount of money would have been worth it if it had been saved over a person’s lifetime or used to pay down escalating debts.
Getting To The Bottom Of The Pot
Though this may not happen 365 days per year:
- We’ll assume that multiple cups, a snack here and there plus a tip, averages out to $6 each per day.
- We’ll assume, for the sake of simplicity, that the price never goes up because of inflation,
- We’ll assume that there are no taxes,
- The total expenses are roughly $72 a week, $288 per month, or $3,456 spent per year.
- To keep things simple, we’ll use the annual amount of $3,450.
They both love what they do and plan to work at least until the age of 75. Between the ages of 35 to 75, a 40-year span, latte dollars spent add up to a whopping $138,000. Wait; we’re not done yet. Their financial professional zooms in and reveals to them the real “Coffee Cost” or the true lost opportunity cost.
Earning a conservative 3% per year in their savings account, had they been as diligent savers as they are coffee drinkers and pocketed the combined $12 per day, what would their savings account look like by age 75?
Their balance grew from $138,000 to $267,938.38 ! That’s almost $130,000 in interest! Yes, they would have to pay taxes on the $130,000, but we’ll ignore it for simplicity’s sake in this example. In simple math, their price per cup is not $6 but about $9.18 per cup. Hello!**
Now, by contrast, let’s say that Ray and Liz are savvy savers and have been averaging 8% annually in their savings,
At the end of 40 years, their ending balance is $965,244.59, raising their cost per cup up to $33.06.**
**Actual results will vary
Note: This hypothetical example is for illustrative purposes only, and its results are not representative of any specific investment or a mix of investments. Actual results will vary.
Painful as this scenario is, there is still another chapter in Ray and Liz’s story that needs addressing. Their increasing credit card debt.
According to a study from Elite Personal Finance, Average Credit Card Debt in America 2021: Statistics and Key Findings, the national average for millennials is $4,322.
Though Ray and Liz’s balance waxes and wanes, we will assume that they’re carrying this amount for the next 40 years at the national average credit card interest rate of 14.65% in 2021.
At 14.65%, their balance is a mind-boggling $7,986,346.03. Lost Opportunity Cost takes on a whole new meaning!
With credit cards as well as other debt, Ray and Liz would not be able to compound the interest out interrupted on their own. The credit card companies, on other hand, know this all too well and are lining their bank accounts with a sizeable portion of the $7.9 million. Since they are currently borrowing at the national average rate of 14.65%, this is their true cost of money.
Assuming they saved their $3,450 + 14.65% annual interest each year at their savings rate of 8%, it would still grow to $1,106,654.32 at a cost of $37.90 per cup.
No Need To Be Depresso
Here is the good news: There is no need to forego your cup of coffee or your latte. I certainly haven’t, though I do own an awesome coffee maker, grind, and brew at home. Whether you’re a true coffee lover or just simply enjoy visiting your local coffee shop for its ambiance and social bond, it is possible to enjoy a regular latte habit while still managing your finances responsibly. David Bach mentions that “the latte factor” is a metaphor: The latte is not the problem. It’s the fact that many of us spend more money than we can truly afford on stuff we really don’t need or value. As one of my mentors shared with me early on in my career:- “If you don’t save for a rainy day, you’ll get wiped out by heavy dew!”-
By working closely with their financial professional, Ray and Liz will be able to find ways to minimize their expenses and costs. Using a commonsense approach to money and its multiplier effect will serve two-fold: It will help them recapture lost opportunity cost dollars and redirect them towards the protection side of their portfolio or for anything they desire.
When planning for your financial future, careful and prudent consideration must be given to increases in expenses and costs. The most damaging examples of these are the ever-increasing, cashflow-eroding cost of taxes and inflation. It is crucial to identify these costs and look for areas where you can be more efficient and find the money you could be losing unnecessarily. This will help solidify your financial future or increase your standard of living without having to change your current lifestyle.
Managing their budget, that magical morning dose of caffeine can be incorporated into their day-to-day spending. They can then relax and feel free to enjoy all of the high-quality lattes they can afford. The lost opportunity cost will no longer interrupt their pastime pleasure.
Note: Though the characters in this article are real, the examples are hypothetical and for illustrative purposes only. They assume a steady 6% annual rate of return, which does not represent the return on any actual investment and cannot be guaranteed. Moreover, the examples do not take into consideration account fees and taxes, which would have lowered the final results. Speak with a financial professional about how these examples might relate to your own investment circumstances.