Monday, August 09, 2010

Cost of Money

Opportunity cost is the cost related to the next-best choice available to someone who has picked between several mutually exclusive choices.[1] It is a key concept in economics. It has been described as expressing "the basic relationship between scarcity and choice."[2] The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently.[3] Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.

The concept of an opportunity cost was first developed by John Stuart Mill.[4]. This definition is taken from wikipedia. This topic really has intrigued me the past month because my girlfriend and me have been talking about settling down and starting a family. Its basically a talk BUT she doesnt know the SECRET plans that i have in store because i want it to come as a surprise. Anyways, talk of marriage made me think and reevaluate my current position in life emotionally and financially. With increasing costs all around us, it made me think, how much should i save with what i earn? Will it be enough? How much do you need to be able to raise a family? How much should one save for a rainy day? What is extravagant spending? Then it made me realize that using the credit card can be good because you get a “float” of one month but this is assuming you have the discipline to control your buying. Im really working hard so that my monthly expenses can be paid by my bank deposit's monthly interest and i realized that it can be achieved if you live a simple life. :-) i've met people and friends who spend a lot and some who are freebies but i guess its different strokes for different folks. There is no correct solution and do whatever works best for you. Some people can spend a lot on their holidays, cars, houses, clothes, bags and whatever you can think of. People have different resons on how they spend their money maybe because ownership of the said item makes you feel “cool” and maybe also the influence of the media and advertising. But when you spend your money on something you lose so much more not just the amount you spent which is basically opprtunity cost. I have always wanted to have a motorcycle and the cost of a good one is around the P500,000 range and assuming i bought it how much did i lose?

Assuming i can get 3.2% interest net from the bank my 500,00 in these number of years would have been worth:
5years 516,000
10 years 685,120.52
15 years 801,983.56
20years 938,780.26
25 years 1,098,910.79
30 years 1.286,355.25
assuming i put the 500,000 in an investment that can give me 8%net per annum then i would have
5years 734,664
10 years 1,079, 462
15years 1,586,085
20 years2,330,479
25 years 3,424,238
30 years 5.031,328
this is the power of compounding working at its best. But i should say you will lose even more because we havent taken into account the yearly depreciation, gasoline expenses, if you took out a loan to buy it and repairs. So in the end you will lose even more.
What if i bought a car worth 3million with a resale value of 1m after 5 years how much will you lose?
Theoretically you lost 2million. Cost of the car less the resale value. So ill put a chat here amounts if you put your money in an investment that can give you a compounded rate of return of 8% and 15%

2million at 8% compounded return
5 years 2.938,656
10 years 4,317,850
15years 6,344,338
20 years 9,321,914
25 years 13,696,950

2million at 15% compounded return
5years 4,022,714
10years 8.091,115
15years 16,274,123
20 years 32,733,074
25years 65,837,905

what if you put the whole 3million in an investment that could give you an compounded returns of 8% and 15%
3million at 8% compounded return
5 years 4,407,984
10 years 6,476,775
15 years 9.516,507
20years 13,982,871
25 years 20,585,426

3million at 15% compounded return
5years 6,034,072
10years 12,136,673
15years 24,411,185
20years 49,099,612
25years 98,756,858

after doing the calculations it made me so happy that i knew better in where to spend my money cause all these talks of settling down has definitely made me more conscious of my finances. As the saying goes 'your future starts today'. For success two elements are important planning and execution. Now that i have made the plan now its up to me to execute it. God bless :)