Dollars and Sense

Expenses - they never retire.

Thinking about money literally messes with our heads.

This contradiction occurs, in part, because he puts that casino spending into a different “mental account” than the coffee. By taking his money and converting it into pieces of plastic, he opens an “entertainment” fund, while his other spending still comes out of something like “daily expenses.” This trick helps him to feel differently about the two types of spending, but they’re all really part of one account: “George’s money.”

George is excited to get free parking and free drinks. Sure, he’s not paying for them directly, but these “free” things get George to the casino in a good mood and impair his judgment. These “free” items, in fact, extract a high cost.

Money represents VALUE. Money itself has no value. It only represents the value of other things that we can get with it. It’s a messenger of worth.

We must make choices. We must make sacrifices; we must choose things not to do. That means, we absolutely must, consciously or not, consider opportunity costs every time we use money.

Opportunity costs are alternatives. They are the things that we give away, now or later, in order to do something. These are the opportunities that we sacrifice when we make a choice.

So, opportunity costs are what we should think about as we make financial decisions. We should consider the alternatives we are giving up by choosing to spend money now. But we don’t think about opportunity costs enough, or even at all. That’s our biggest money mistake and the reason we make many other mistakes. It is the shaky foundation upon which our financial houses are built.

when we fail to consider these opportunity costs, the odds are that our decisions are not going to be in our best interests.

In the $300-for-CD case we know what we’re getting. It is tangible and easy to evaluate. When the $300 is abstract and general, we don’t conjure up the specific images of how we’re going to spend it, and the emotional, motivational forces on us are less powerful.

people don’t tend to naturally consider alternatives, and without considering alternatives, we can’t possibly take opportunity costs into account.

spending money now on one thing is a trade-off for spending it on something else—thinking this way is too abstract. It’s too hard. So we simply don’t do it.

“What is this worth to me? What am I willing to give up for it? What is the opportunity cost here? That is what I will pay for it.”

​Some people go on a $10,000 vacation but spend twenty minutes each day looking for free parking.

When it is hard to measure directly the value of something, we compare it to other things, like a competing product or other versions of the same product. When we compare items, we create relative values.

The problem isn’t with the concept of relativity itself, but with the way we apply it. If we compared everything to all other things, we would consider our opportunity costs and all would be well. But we don’t. We compare the item to only one other (sometimes two). This is when relativity can fool us.

Sixty dollars is relatively cheap compared to $100, but remember opportunity costs? We should be comparing $60 to $0, or to all of the other things we could buy with $60. But we don’t.

Bargains also make us feel special and smart. They make us believe we’re finding value where others haven’t.

When relativity comes into play, we can find ourselves making quick decisions about large purchases and slow decisions about small ones, all because we think about the percentage of total spending, not the actual amount.

Relativity is built on two sets of decision shortcuts. First, when we can’t assess absolute value, we use comparisons. Second, we tend to choose the easy comparison.