When You Treat Yourself, You Cheat Yourself
A new mental model for purchase decisions
There is no Santa Claus. Your dog didn’t go live on a farm. Your parents are human beings. Life is often unfair.
Brace yourself for another bombshell.
A price tag does not display the true cost of a purchase.
Most ideas that shake your belief in the status quo seem at first absurd. A cheap pack of gum is on a shelf for $1. You hand the impulse purchase to the cashier, you pay your buck and you start chewing. It cost you a dollar.
It would, indeed, cost a dollar if you were financially independent and using passive income. But if you’re using your paycheck to finance the purchase, it likely costs you astronomically more than it’s worth.
A famous economist once said, “There’s no such thing as a free lunch.” Other than economists not having friends, what does this even mean?
The reason a lunch that you pay $0 for isn’t free is because of a concept called “opportunity cost”. You need to include what you’re giving up — the lost opportunity — as part of the costs. Even if you’re familiar with the concept, though, I bet that you are thinking about opportunity cost too narrowly and grossly underestimating its impact.
Think you know what that pack of gum actually cost you? Keep reading.
For Those Who Crammed for Econ 101, a Refresher
Let’s say that you have two free lunch options: fine dining or fast food. The actual cost of a “free” fine dining lunch is the fast food lunch. You have to forgo one option to seize the other. If you have many options, the opportunity cost is the value of the best alternative.
Let’s say you need to wait in line for an hour for your “free lunch”. You have to take off an hour from work, where you make $20 after tax per hour, to line up. That “free lunch” is actually costing you another $20 because your time is worth something.
Maybe you had to pay $5 for parking for your “free lunch”. Associated costs that you would have not incurred otherwise need to be included, as well.
In this example, your “free lunch” costs you a fast food lunch, an hour of time worth $20 and $5 in parking. Free never sounded so expensive!
Now that we have the definition and example out of the way, let’s extrapolate what your nonchalance about the gum implies.
Don’t Treat Yourself Like You’re Worth 50 Cents an Hour
The title of this section seems obvious. You would never treat yourself so poorly. Humor me and affirm to yourself that your time is worth more than fifty cents per hour, and only then read on.
“A penny saved is a penny earned” means that your savings account is indifferent between you 1) saving an extra penny by not spending it, and 2) making an extra penny. Either way, you have an extra cent on your balance sheet. In The Wealthy Barber, author David Chilton points out, “A dollar saved is two dollars earned”, when you take a high income tax bracket into account. Now I’m going to take the saying a step further and take time into account.
A dollar saved today is $90 earned in forty years.
I know, it blows my mind too. If that were accurate, no one under the age of forty would be going out for lunch every day. It couldn’t possibly be true… right?
Let’s say you’re twenty years old and save $1. One dollar compounding at a 10% interest rate for 40 years is $45. If your marginal tax rate later in life is 50%, the opportunity cost of spending the $1 when you’re twenty years old, is earning an additional $90 when you’re sixty years old. If you were to make $45/hour when you’re sixty, then it would take you 2 hours to make that up.
When you buy that pack of gum when you’re twenty, you’re really trading 2 hours of life away from your future sixty-year-old self.
Put another way, you could save 50 cents today to save one hour when you’re sixty. Recall that a moment ago you avowed that your time was worth more than 50 cents per hour. If that is true, then you would not buy the gum.
While the gum costs just $1, a thousand-dollar purchase would take 1000 times more hours to make up. Instead of 2 hours, it’s 2,000 hours, or a whole year! A sixty-year-old who is still working could have retired a whole year earlier if they had saved just $1,000 more when they were twenty and passively invested it at 10% per year. This is the concrete tradeoff you make when you choose to spend thoughtlessly today and aim for traditional retirement.
Until you reach financial independence, everything you buy costs time from your future self. The true cost is years of your life. As Henry David Thoreau said, “The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.”
Once you reach financial independence, your investments fund all of your expenses. While there will still be an opportunity cost of a pack of gum because you could reinvest the dollar and buy something more expensive later, the decision to buy the gum has no impact on your not needing to work. How you spend your time is no longer part of that equation.
I am sure you value your later years at more than fifty cents per hour. Unfortunately, if you’ve already made it rain dollar bills at a pool party in Vegas, those dollars did stay in Vegas. There is no turning back time. You can, however, start today to adjust your spending to reflect how much you value your days. Don’t make it rain with your hard-earned dollars. If you must, make it pour with your passive income in ten years.
Right now, every dollar matters.
It Gets Worse
“The Latte Factor”, coined by David Bach, points out that small, recurring purchases can have a huge impact on your financial health. In the last section, we examined the opportunity cost of $1 spent just one time. But what if you buy a $5 coffee (or whatever your little hit is) every day? What would that cost you? And how much could you have earned if you had invested the pocket change instead?
Make sure you’re sipping wine for this so that you have something to spit out.
Five dollars spent on each of the 365.25 days in a year costs $1,826.25. That’s a vacation. Over 40 years, though, that’s $73,050. For most people, that’s more than they make in a year. And that $73,050 is from after-tax income. But wait, we’re still missing the opportunity cost.
If instead of spending that $5 per day, you invested that money twice a month at 10% annual interest in a tax-free account, your statement after 40 years would read…. drumroll… $846,374!
I enjoy aromatic pour-overs as much as the next snob, but not for $846,374. That’s enough, with a 10% return, to earn $84,637 in interest every year. I would gladly forgo the floral notes of Geisha coffee for all of the things that $84,637 could buy me every year for the rest of my life.
Coffee may not be your thing, but the concept applies to all spending. Let’s look at some other common treats and their opportunity cost when you invest the savings semimonthly for 40 years at a 10% return.
Bottled water @ 60¢/day
= $101,565
Gym membership @ $60/month
= $333,683
Eating lunch out on weekdays @ $60/week
= $1,445,962
Smoking a pack of cigarettes per day in New York @ $75/week
= $1,807,452
Find a few of these habits and the opportunity costs add up quickly. If not from smoking, you probably have a combination of small purchases that add up to $75 per week. I don’t even want to think how long it would take to save over $1.8 million (and that’s after taxes and expenses) if I started in my fifties or sixties. It is so much easier to cut costs early in life than to work hard to make the same amount in income later.
Opportunity Cost of Working
Believe it or not, we’re being too conservative. Working for fifty cents per hour neglects all of your additional time and expenses associated with the job that you wouldn’t have otherwise incurred.
If you commute an hour each way to go to a tutoring appointment that lasts only an hour, that’s actually three hours of your time, plus your transportation costs there.
Most people also have costs incurred only because of their job. Maybe you eat out for breakfast and lunch because you have no time or energy to cook. Maybe you reward yourself for a job well done with a biweekly manicure. Maybe you own a car to ease your commute. Maybe you take a vacation just to lounge on the beach to decompress. Maybe you buy a closet full of expensive clothes that you would never wear outside of work because, let’s be real, they are hideously bland.
Your body may also take a toll. Too tired to exercise regularly, you may require blood pressure pills later in life. Your idiot boss stresses you out and drives you to take anxiety medication. Your hair greys early and now you are a favorite client of your hairstylist.
When you add on the additional time and costs spent to perform your work, your hourly wage is lower. Your future self is actually working for even less than fifty cents per hour.
Being Intentional
The point of this article isn’t to fill you with guilt every time you add to cart. Rather, this framework exposes the actual cost behind a price tag so that you can make better informed decisions and live a life that is intentional.
Fear not: you will not be working when you are sixty if you follow the tenets of Financing Future You. I do, however, recommend highlighting and returning to this article until your neurons pair opportunity cost with all of your spending. This will help you stay on track. From my master’s degree in economics, I can tell you (saving you the drudgery of earning a degree that requires econometric proofs) that opportunity cost is the field’s most life-altering concept. It’s not rocket science, but its application can launch you pretty far.
While you do not need to run a calculation each time you make a purchase, your future self’s time should always be in the back of your mind. (This is difficult because Future You is abstract, but upcoming articles will address how to make Future You concrete). You work extremely hard for every dollar you make and it is a disservice to yourself to spend without taking your labor into account.
In practice, all you really need to know is that seemingly small purchases frequently cost you more than they are really worth. The choice is always to sacrifice a smidgeon now or a ton later. That is the real tradeoff.
The leaner you spend now, the exponentially more time you save Future You. Present You will never deprive yourself, though, because you are the one determining your own limits.
Time is our most precious resource, especially because it is not renewable. Life is too short to spend decades clocking in and out. Spend like your life depends on it.
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