Financing Your Life A Guide to Controlling Your Finances, Today
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The debt that you carry from month to month has a cost. You might think the cost is simply the amount
of interest you pay, but when you understand both the concepts of opportunity costs and the time value
of money, you’ll see just how expensive your debt really is.
Exploring Opportunity Costs
When you choose to take on debt, you are forfeiting income for a period of time in your future in order
to pay back that debt. You could, instead, have used that future income to invest in stocks, bonds or CDs
that pay interest. You could have used it to invest in a retirement account and gain a tax savings. It
might also have been used to pay for a future emergency that now will instead need to be paid for by
creating even more debt. You also could have used it to improve your home or other assets so they are
worth more upon sale. All of these alternative uses are “opportunities” that you forfeit when you decide
to take on debt.
Understanding the Time Value of Money
Did you know that the money you have available to you right now is actually worth more than the same
amount will be in the future? It’s true. Between inflation, which decreases the buying power of your
money, and the potential to grow today’s funds to accumulate larger balances in the future, your
present-day dollars have a much higher value. But when you tie your free money up in debt, you
squander that present value—because that money is now obligated to pay off a debt and interest rather
than grow or exert its true buying power. And while you will have free money later after you pay off the
debt, that won’t be as powerful as having the money now would be.
Between the time value of money and opportunity costs, your debt could be costing you a comfortable,
stable, independent future. In order to really measure the cost of your potential debt and determine
whether it’s worth taking on, you need to consider these two costs and how they will impact your future
plans and goals.
