Wealthy people are very good at managing their downside – simply put, understanding what they stand to lose.

Now on the other hand, most consumers end up battling financially because they spend too much time getting excited about what they stand to gain instead of spending enough time calculating the medium to long term effects of their decisions.

Wealthy people follow 2 important rules:

Rule #1: Never lose money

Rule #2: Follow Rule #1

As funny as this may sound, this formula is gold to someone who wants to end up wealthy because they work damn hard to make their money.

The way to get this right is to get good at calculating your ‘opportunity cost’

According to businessdictionary.com an opportunity cost is a benefit or profit that must be given up to acquire or achieve something else. Now that ‘something else’ may be more profit, but it could also mean less profit. This reality is the key to making good financial decisions.

I heard Warren Buffet (the richest man in the world) once say that when he looks at buying a new business he first wants to find out about all the things that can go wrong in the business before he is willing to listen to how amazing this opportunity is. This way, he understands his downside (risk) before he calculates the benefits of buying the business.

Here’s a great example of how some consumers attempt to not pay their accounts when money is a bit tight without understanding their opportunity cost.

What they do is after their salary is deposited, they quickly withdraw all the money out of their bank account so when their monthly account payments are supposed to be paid there is no money in the account. This way they manage to avoid making the payments so end up with a bit more spending money. In their mind they’ll get to paying off their accounts soon, so no harm done.

Ok, so the opportunity is they will end up with a bit more moola this month now let’s look at the cost. When you miss a payment on your bank account you can end up paying around R90 per transaction you dishonoured. (Per account you didn’t pay)

So let’s say you had 4 accounts you were supposed to pay for the month and didn’t pay them, these would be some of your costs:

  1. R360 (R90 x 4 missed payments)
  2. You would still be charged the interest on the debt for the month
  3. Possibly charged penalty fees by the creditor you have an account with
  4. Be handed over to a collections department which can come with serious costs because a bunch of lawyers or debt collectors will now start charging to collect money from you. (These costs by the way are yours!)
  5. These missed payments will show up on your credit record every time you do this and will count against you if you want more credit. This makes buying a car or house very difficult.

In summary these 5 penalties would be the costs you pay for the opportunity of having a bit of extra money for the month. The scary thing is that we come across thousands of customers who used to do this all the time until they understood their downside. Annually this can work out to massive amounts of money you now owe.

My advice: Remember the 2 rules wealthy people follow and please… spend enough time weighing up the opportunity costs of your financial decisions in life.

Author: Gary Kayle – Money Coach, The Money School