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Have you ever heard of the concept of opportunity cost? What does it really mean, and why is it so important when it comes to managing your finances? Today, we're going to break it down in simple terms.

Recapturing Lost Opportunity Cost To Create Wealth

There are a lot of elements to consider when it comes to opportunity costs, but don't worry, I’ll keep things straightforward. Whether you're just starting out on your financial journey (rebuilding credit, getting out of debt, or forming better habits) or you're looking to take your finances to the next level, understanding opportunity cost is crucial.

The more aware you become of these financial dynamics, the more control you'll have over your money, and the more efficiently you can work towards your goals.

To make it even clearer, let me share a couple of simple examples that show just how small changes in your approach can lead to significant results in your life. I’m confident that every single person reading this will benefit from making these adjustments.

Whether you're reevaluating how you purchase a car or, if you're a business owner, considering major capital investments and financing equipment, these small shifts in mindset can make a big difference in your financial strategy.

The key point here is that every time we make a purchase (whether it’s a car, equipment for a business, or anything else) there’s an opportunity cost involved. In other words, each decision we make comes with a trade-off. Let’s dive into the framework of opportunity cost and explore how the cost of capital plays a role in our everyday lives.

Control The Cost of Capital To Create Wealth

To put it simply, the cost of capital refers to the interest rate you pay when borrowing money for a major purchase. For example, let’s say you're buying a house. A few years ago, the cost of capital for a mortgage might have been around 3%. It was much cheaper back then. Fast forward to today, and mortgage rates are hovering around 6.5% to 7%. Of course, these rates fluctuate over time, depending on the market.

But the important thing to understand is this: the cost of capital is a critical factor in every financial decision. If you can control this cost (if you can optimize the rate at which you’re borrowing money for any significant purchase or investment) you’re putting yourself in a much stronger position to reduce opportunity costs and increase the opportunities available to you.

Now, let’s dive into a couple of key concepts that I believe are crucial to understanding how to manage opportunity cost and optimize your financial decisions.

What Is the Opportunity Cost?

At its core, opportunity cost is about recognizing that we’re always paying interest, whether it's direct or indirect, on everything we buy. Every purchase comes with an interest expense, and that’s the fundamental concept behind opportunity cost.

Now, some people might say, "Wait a minute, Chris. That's not fair. I pay cash because I want to avoid opportunity cost and interest expenses." But here’s the thing: even when you pay cash, there’s still an opportunity cost. The interest expense isn't just about what you're paying on a loan, it’s about what you're not earning when you use that cash. Let me give you an example to explain further.

For example, let’s say you have money sitting in a high-yield savings account earning 5%. Now, imagine you decide to buy a car, and the financing rate for the car is 2%. You think, "I don’t want to pay that 2% interest, so I’ll just pay cash." But by doing that, you’ve made a 3% inefficient decision. Why? Because while you avoided the 2% loan expense, you lost the opportunity to earn the 5% interest from your savings. In net terms, you’ve lost 3%.

And it’s actually even worse than that because money in a savings account compounds, while the interest you pay on an amortized loan is typically fixed. The key takeaway here is that in life, you're always faced with a choice: you either pay interest to a bank or you forgo the opportunity to earn interest on your own money.

When you understand that concept with your own money and opportunity costs, now we're able to start seeing how we can solve this problem.

To really drive this point home, let’s expand on the example. Imagine we’re looking at a $50,000 car. I’ll use this example to illustrate the financial dynamics at play, highlighting the decisions debtors typically make. Whether you’re financing or paying cash, understanding how opportunity cost applies to this $50,000 purchase is key.

How To Increase the Efficiency of Buying A Car To Create More Wealth

Let’s consider this: the average American buys a new car every five years. For simplicity, let’s say each car costs $50,000. You purchase the car, pay it off, and by the time it’s paid, you’re back to square one, ready to start the process all over again. Over the course of a lifetime, the average American goes through seven car-buying cycles. For the sake of this example, though, I’ll illustrate it using just four cycles to keep things straightforward.

Now, let’s break this down further. At a 5% interest rate, financing a $50,000 car would result in about $10,000 in interest expenses over the loan term. That’s a 20% increase in the cost of the car. Understandably, many people think, I don’t want to pay that extra cost, I’ll just pay cash instead.

However, paying cash comes with its own opportunity cost. If that money had been sitting in a high-yield savings account earning 5%, you’d lose the ability to let it grow and compound. By withdrawing the cash, you’ve interrupted the compounding process and forfeited the long-term financial benefits it could have provided.

To truly grasp the impact, we need to understand the concept of the compound growth curve. Imagine this: with $50,000 sitting in a high-yield savings account earning 5%, you’re generating $2,500 a year in interest. Over time, this growth begins to build momentum, compounding year after year.

But when you decide to use that $50,000 to avoid paying $10,000 in loan interest, you’re effectively "spending down the golden goose." By doing so, you interrupt the compounding process and forgo the future earnings that money could have generated.

Now, I’m not here to argue that savers are always in a better position than debtors. The truth is, while savers might seem to have an advantage, they’re often not as far ahead as they’d like to believe. Here’s the key takeaway: at the end of every car-buying cycle (whether you’re a saver paying cash or a debtor financing the purchase) you both ultimately end up back at zero.

Here’s why this matters: when you pay cash for a car, you still have to start saving again for your next car. Cash flow-wise, there’s no real escape, you’re continually setting money aside unless you’re willing to become a debtor in the next car-buying cycle.

From this perspective, it’s clear that cash flow is the key factor. And at the end of the day, buying a car is ultimately a lifestyle decision, one that should be evaluated with your overall financial strategy in mind.

Fair enough, the car you choose to drive is ultimately a lifestyle decision. I’m not here to tell you whether you should buy a $50,000 car or something entirely different. Your values and beliefs are your own, and you’re free to make those decisions as an adult.

What I do urge is this, if you’re going to buy a car, take the time to understand opportunity cost and learn the most efficient ways to make that purchase. Looking at the bigger picture, after four car-buying cycles, or even seven, the outcome remains the same. You start at zero and end at zero.

At that point, your options are limited, you either drive an old beater for the rest of your life or continue the cycle of saving or going into debt to keep buying cars. And if you’re retired, unless your financial situation is exceptionally well-planned, there’s no guarantee you’ll have the resources to sustain the cycle.

How To Optimize Wealth Creation By Controlling Opportunity Cost

Here’s where I introduce what I call the Wealth Creator approach. This method involves using whole life insurance to establish a kind of personal banking system. Whole life insurance serves as a foundational asset because it allows you to borrow against the cash value of your policy without interrupting its growth.

Essentially, you’re adopting saver-like behaviors by consistently saving, while simultaneously leveraging the insurance company’s money. By using the cash value of your policy as collateral, you can finance purchases efficiently without sacrificing the compounding growth of your own funds.

The beauty of this approach is that the money in your policy continues to grow uninterrupted, even as you borrow against it. This concept (often referred to as "becoming your own bank" or infinite banking) revolves around leveraging your assets while maintaining their growth. If you’re considering this strategy, it’s essential to proceed with caution. Be mindful of who you take advice from, as this isn’t about chasing positive arbitrage; it’s about creating a sustainable and efficient financial framework.

This strategy isn’t about buying into flashy or gimmicky marketing ideas. It’s about practicing solid financial discipline, adopting smart behaviors, and aligning your money with your core values and beliefs. Here’s how it works: as you go through these car-buying cycles, you may borrow funds, but instead of paying a bank, you repay the insurance company. Meanwhile, the money in your policy continues to grow, compounding over time.

The key difference is that the money you have in your policy continues to grow after each cycle, thanks to uninterrupted compounding. This allows you to leverage your funds without sacrificing long-term growth. The growth in your policy’s value will typically outpace the simple interest you would pay on a loan from the insurance company. Many people ask, Why would I pay interest to borrow against my own money? The answer is: you’re not borrowing your own money.

Let’s say, for example, you’re paying the insurance company 5% interest on the money you borrow. If you can earn 5% within your policy, the net result is that your money still grows while you’re using it. The key is that you never interrupt compound interest, and this approach allows you to mitigate the opportunity costs of making lifestyle decisions.

While you’ll never completely eliminate opportunity costs in these decisions, understanding how to manage and minimize them is crucial. This is something many financial strategies overlook, but it’s essential to recognize that with the right approach, you can reduce the impact of opportunity costs significantly.

The more we can mitigate opportunity costs, the more we can recapture and use that to create wealth. And here’s the powerful part: over seven car-buying cycles, someone buying a $50,000 car could potentially recapture $250,000. Now, let that sink in. Did you know that the average 65-year-old in the U.S. has only $237,000 saved for retirement? That’s the average amount in retirement funds, which is sobering when you think about it.

Just by changing the way you buy cars (by shifting your behavior, your process, and being willing to delay gratification) you can put yourself in a much stronger financial position. If you start implementing a strategy like this, you’ll be in a better position financially than most people in this country, which is truly sad when you consider that the U.S. is the most financially prosperous nation in history. Yet, 95% of people will struggle to maintain their standard of living in retirement. That, to me, is the real crisis, more so than the distractions we’re often focused on.

So, understanding these numbers and the way finance works in our everyday decisions is key. Whether you pay cash or take out a loan, you’re always financing your life. Paying cash is a form of self-financing because by doing so, you interrupt the compounding growth of your money. Now, you’re on the hook to save and create cash flow to rebuild what you’ve spent.

Focus on Cash Flow Planning - NOT Investing for Accumulation

If we start looking at life through the lens of cash flow, asking ourselves, How does this decision impact my cash flow from a long-term perspective?, we begin to approach our financial decisions with more clarity.

This mindset forces us to consider not just the immediate benefits, but the broader picture. Then, we can connect this thinking back to our goals, objectives, and core values. What is our mission in life? What do we want to achieve, and how do our financial choices align with that vision?

What’s my vision for my life? What do I want it to look like? Once I’ve clarified that, I can reverse-engineer a plan and start thinking through the lens of cash flow, implementing the necessary steps to align my finances with my vision. That’s the essence of this approach.

I hope this has made sense and given you enough clarity to take the next steps. If you’re ready to move forward, I encourage you to have a conversation with someone and explore what this could look like for you. If you haven’t already, I highly recommend setting up a clarity call with a member of the LIFE180 team. If the person who shared this article with you is part of the team, reach out to them directly.

Go through the Values and Beliefs workbook, fill out the financial x-ray, and get your financial efficiency in order. By doing this, you can take control of your financial results and move closer to your goals.

Start thinking about cash flow hacking, investing with the goal of creating cash flow to achieve the life you desire. Don’t focus too much on the returns right away. The returns will come, but you’ll need to take risks and actively pursue them.

This won’t happen inside your policy, that’s for building a solid foundation. Real estate, business, or other strategies are where you’ll take those risks. But before you can run, you need to walk. Building financial structure is the first step.

You’ve got to be willing to go slow to go fast, that’s what this strategy is all about. With a little discipline, you can achieve your goals much faster than you might think. If you have any questions, don’t hesitate to reach out.

Our team is here to help, and the person you connect with will guide you every step of the way. Click the link below to set up a clarity call, answer the questionnaire, and take the next step toward financial efficiency. We look forward to serving you.

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Have a blessed and inspirational day.