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Chris Farrell: On financial opportunity costs

  • Article by: CHRIS FARRELL
  • October 12, 2013 - 2:00 PM

I gave a talk recently on personal finance and financial literacy at Century College in White Bear Lake. Students, teachers, and people from the surrounding community (including a furloughed federal government employee) crowded into a conference room. The students were engaged and asked good questions. Events like this push me to focus on what’s really important when it comes to managing money.

For instance, it’s all too easy to equate personal finance with understanding the twists and turns in 401(k)s and IRAs, CDs and Treasury bills, whole life and term life, the stock and bond markets and other staples of the business. But these are just tools.

Personal finance is really about deciding how to live your life, figuring out what you value and putting your money behind your goals and beliefs. Personal finance is part of the lifelong endeavor to create a good life. Our relationship with money is an ongoing, evolving enterprise as our goals change and our ambitions shift.

Another aspect of managing money we discussed at Century College is appreciating trade-offs. You’ve probably heard the phrase popularized by the late Nobel laureate Milton Friedman, “There is no such thing as a free lunch.” I prefer the Rolling Stones lyric “You can’t always get what you want,” to make the same point.

Economists call the value of the goods and services you sacrifice in undertaking any activity an “opportunity cost.” The concept is an imprecise measure of cost and benefits of trade-offs. Thinking about opportunity cost helps us understand the return we expect from our choices.

For example, a question came up at Century College: Is a college education worth the cost? The price paid for attending college isn’t only the dollars spent on it but also the value of your time spent at school, and the alternative uses of that time. The students in the conference room could have been working and making an income instead of being in college. They’re attending school because they believe their return in enlightenment, enjoyment, careers and income exceeds its opportunity cost — the money spent on college and the time it takes to earn a degree.

My response: Congratulations for attending college. Yes, it has been a rough couple of years for any young person with post­secondary education. Nevertheless, the underlying trend in the labor market is toward lifetime rewards from education. For instance, in 1970 about a quarter of jobs required post­secondary education, a figure that swelled to 59 percent in 2010, according to the Center on Education and the Workforce at Georgetown University. The center forecasts that nearly two out of every three U.S. jobs will require at least some postsecondary education by 2020.

The trick is to limit how much is borrowed to earn a degree. Workers will increasingly face an opportunity-cost decision about education and training throughout their lifetimes and not primarily when young. Job market instability is becoming a way of life in a hypercompetitive global economy. Workers face the prospect of multiple jobs and even multiple careers. It’s a major reason why savings are critical. Savings can be tapped to voluntarily fund multiple job and career transitions over a lifetime. Many of these potential job and career shifts will require additional education and training. The opportunity cost of saving more now pays off over a lifetime.

Chris Farrell is economics editor for “Marketplace Money.” His e-mail is cfarrell@mpr.org.

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