It happens to the best of us. We make frivolous purchases that we may not need, but convince ourselves we deserve ... that specialty morning coffee, that handbag we spot for ourselves while actually shopping for someone else, concert tickets for the show that everyone can't miss. Especially during this spending-heavy season, it can be helpful to remember that every dollar you do spend is a dollar that you don't invest. Every time we make a purchase, we're losing not only the money we spend, but also the money we could have made on interest or investment returns: this is the "opportunity cost."
Objects in the shopping cart are pricier than they appear
In order to help demonstrate the benefits of long-term investing, here's a look at how the values of some everyday purchases could grow over time if invested in the market. As a unit of measure, we'll use the average rate of return for long-term investments: around 9%, according to NYU's Stern School of Business. After subtracting the average inflation rate since 1913 of 3%, we will assume a 6% rate of return on our long-term investments.
Now, those numbers look pretty rosy. Of course, when you chart out the daily closing prices you see some rather dramatic ebbs and flows. Here are the daily movements of the S&P 500 stock index since 1993:
The lesson here is that despite daily upticks or downticks, the market is trending up over the LONG term. The key to getting rewarded with returns is investing early, and giving your money plenty of time to grow.
Now, take a look at some everyday purchases and see what we're truly missing out on by not investing that money.
The $41 coffee
First up: our morning coffee. What would happen to that $4 latte if invested into the market and allowed to grow? This handy investment calculator at Edward Jones can help us see the opportunity cost of getting that daily caffeine fix.
For the purposes of this exercise, we'll use two time periods: 20 years and 40 years. That may seem long, but that's kind of the point, right? Committing to a long duration is how we best avoid those dangerous dips and spikes above.
If we plug in the aforementioned 6% annual rate of return, our $4 investment has jumped to $13 in value after 20 years. Coffees for everyone! Hang in a little longer, though, and your returns could net you your own coffee maker; the value of that $4 rises to $41 after 40 years. Not bad, right? Still stopping by Starbucks tomorrow morning? Maybe that free coffee in the office isn't so awful.
The $617 video game
Now, let's up the stakes. How many of you splurged on NBA2K14 a couple weeks ago? It's a fun game, sure, but would you still have spent that $60 if you knew that 20 years later it could have grown to over $192? That's enough for an awesome seat to see LeBron in person, not just via (admittedly pretty great) computer graphics. While you're courstside, don't let that talcum powder hit you in the face while you're thanking yourself for not buying that video game.
Not into the live game-day experience? No judgment here! Just let your investment grow longer. After 40 years, that original $60 improves to a whopping $617, enough to fund all of your video game-consoling needs.
The $1,677 Kanye West concert ticket
All right, now let's get serious. Who among us didn't have the urge to spring for tickets to the "Yeezus" tour? At $163 per ticket, seats to Kanye's latest concert come with quite a bit of opportunity cost. If you chose to invest that money instead, then after 20 years you'd have $523. That's enough to buy premium headphones, a sleek pair of leather jogging pants, and a bottle of champagne. That's basically the exact Kanye West concert experience, just in the privacy of your own home.
After 40 years? That $163 grows to $1,677. Boom. Get yourself a Google Glass headset. Kanye's also an early adopter in the fashion world, so you know he'd forgive you for not attending that concert all those years ago.
The $5,143 plane ticket
As you can see, the greater (and earlier!) the investment, the higher the returns. Now let's take a look at the opportunity cost of making that most expensive of last-minute purchases: a flight. I've been known to book many a long weekend away at a moment's notice; in an effort to combat that impulse, here are the returns that a $500 investment could earn. After 20 years, the price of that flight jumps up to $1,604. After 40 years? $5,143. This is enough for a killer first-class vacation, traveling to basically anywhere in the world. I'll try to remind myself of that the next time I'm browsing Kayak.com.
So next time you feel like treating yourself by making a "small" purchase, remember that the opportunity cost of investing that money is exponentially larger. Treat yo self by investing in your future instead.