Dangers of opportunity costs

Fast forward to when I had finished uni and landed my first job. I found out about car loans and it was immediately time for an upgrade.

I studied economics for four years at uni and I knew more than any 22-year-old should know about yield curves, hedging, credit swaps, derivatives, micro and macro economic principles and a whole heap of fancy, but practically useless maths. But what I did not know was how much that car loan was truly going to cost me.

I am not talking about how much principle and interest I would pay the bank over the life of the loan, but what could that money grow into, if I invested it instead?

Here an example:

Let's say I signed up for a five year $30,000 car loan. Assuming an interest rate of 6 per cent per annum, the repayments would be around $580 per month. Over the life of the loan, it would cost me $34,799 including the principle repayment and the interest.

Now imagine if I decided to invest the $580 per month instead into a diversified share portfolio for the same five years, reinvested the earnings and then just let it grow. Assuming an 8pc return per annum, simplistically that small investment could grow into:

I thought the car was costing me $580 per month but, the true cost was over $700,000.

This is what economists call the 'opportunity cost'. When you get your head around the maths, you will never look at a car loan the same again.

So, if your kids or grandkids are thinking about getting a car loan, why don't you teach them about opportunity cost. They still might decide to take out a loan but maybe they will take out a smaller loan and maybe invest the balance? Hell, if they take it onboard that one small conversation might make them $800-900k wealthier by the time they are 65.