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Saving Money on Auto Insurance - The #1 Way to Save is to be a Better Driver

We all have our pet peeves when it comes to driving that can range from getting cut off to someone driving entirely too slow on the interstate.  While these serve to annoy us, there is also a financial component to these kinds of behaviors (and no, driving 15 mph below the speed limit is not safe or careful driving).  When we look at auto insurance, there are commercials galore that extol the virtues of one insurance company over the other when it comes to price, but the reality is that if you want to save a lot of money, you need to be a better driver.

Risk Dictates Price

Just like any form of insurance, the level of perceived risk is the number one factor in determining the premiums that will be charged.  If you're a smoker, you can expect to pay more for health, disability, and life insurance.  If you're a bad driver, you will pay a small fortune to the insurance company for the pleasure of driving (and wreaking havoc on other drivers along the way).  To pay the lowest premiums - to save serious green - you need to be a low risk for the insurance company.

Ways to be a Better Driver

For whatever reason, some people simply are worse drivers than others.  Reasons for this range from being overly aggressive to the more common - being careless.  With the latest issue being texting and driving, the studies don't lie.  Distracted driving is extremely dangerous, and as we're pointing out in this post, the added insurance costs are painful as well.

To help you become a better driver, there are dozens of ways to lower your risk profile and your insurance premiums.  The most common are commonsense:

1. Pay Attention - Texting?  Super bad idea.  Talking on the phone?  Not good.  Pointing at landmarks?  Distracting.  Staring at drivers next to you?  Creepy.  Driving a panel van and delivering a death stare to drivers next to you?  Scary.  Look, you already know this, so turn off the phone, stop pointing out landmarks while swerving (we naturally drive toward our line of sight), and please, don't stare at other drivers.
2. Observe Traffic Laws - Ah, the law.  We generally try not to break the big ones, but traffic laws are all too often ignored.  If you've never read a state provided book on traffic laws, pick one up.  You'd be surprised, but there are things that can also help you get around faster (like turning left on red at one way to one way intersections).
3. Scan the Road - We always liked the expression, "You gotta watch out for the other guy."  The problem is that most of us fail to scan the road for possible danger around us because we're focused on getting from point A to point B.  Take the time to look around and avoid trouble when you see it happening.
4. Be Patient - When it comes to rush hour, you're better served being patient.  Changing lanes in horribly slow traffic is unlikely to result in any significant time savings while seriously increasing your odds of being in an accident.  Settle down, and you'll be better for it.
5. Think Ahead - If you need to get off the interstate in a half mile, being in the far left lane on a five lane highway is not thinking ahead.  Of course, you see it all the time where someone isn't thinking ahead and winds up screwing up traffic or worse, causing an accident.  This goes back to the first point - pay attention.

Wrapping Up

While there are other ways to save money on auto insurance, the #1 way to save is to be a safer driver so you will be a lower risk to the insurance company.  There simply is no other way to save that offers as much value as taking the time and investing in being a better driver.  Plus, we'll all be happier that you're not the 'other guy' ruining our commute.

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Why Tiger Woods is NOT a Sex Addict - The Economist's View

Economics is often thought of as a boring subject, and we'll grant you that it's not as exciting as tabloids covering stories like that of Tiger Woods.  But with the U.S. Open underway at Pebble Beach, we thought we'd throw a little spice on consumer preference theory by giving you the economist's view on claims that Eldrick is a sex addict.  Using some simple tools, we'll show that the greatest golfer of our generation is not a flesh addict, just another individual guilty of infidelity.

Consumer Preference Theory

In a nutshell, within the broad subject of economics is something known as consumer preference theory that is used to explain how consumers go about making choices among competing alternatives.  Each of us has limited means and unlimited wants, and economists seek to understand how we allocate our scarce resources in maximizing our happiness.  Of course, economists could never use such a simple word as 'happiness', they instead use the word 'utility' to describe how much satisfaction we receive from a particular course of action.

Diminishing Marginal Utility

One of the core principles of consumer preference theory is that of diminishing marginal utility.  The easiest way to understand this is through a basic example.  We all need to eat, and let's say that our food of choice today is pizza.  When we're hungry, the first slice of pizza makes us feel less hungry.  The second, a little less, and so on until our hunger is satiated.  However, with each successive slice that we eat, our satisfaction gained from each slice of pizza is reduced until at some point we are worse off by eating the next slice.

This is the principle of diminishing marginal utility.  While we may be hungry and in the mood for pizza, there is a limit to how much we can eat and still feel better after doing so.  Eating too much pizza makes us miserable, but eating just the right amount (the optimal choice) is very satisfying.  Graphically, we can show diminishing marginal utility as follows:

Real Addicts

The example above is for someone that isn't addicted to pizza.  But what about a meth addict?  In their world, there simply is never a point at which more meth is a bad thing.  The meth addict that is jones-ing for the next high will be initially relieved to get that first hit.  However, this is just the beginning, as the addict continues to get higher and higher.  There is no stopping point; there is no diminishing marginal utility.  For comparison purposes, an addicts utility increases with each successive fix as shown here:

Wrapping Up

In looking at Tiger's situation, would it appear that he is an addict or not?  We would contend that it is less likely that he is an addict and more likely that he is just a man that made some mistakes.  Had he been a true to life addict, he would never be satisfied and likely would have hundreds, if not thousands of people coming out of the woodwork instead of the dozen or two that have surfaced thus far.  While economics can be boring, it's principles, theories, and laws can be applied in many ways - even to claims of sex addiction.

NOTE:  We make no judgments on Tiger Woods' choices, and are merely exploring the subject of economics through the headlines from the last several months.  Any diagnosis of addiction is better left to those in the field of psychology.

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Should You Carry Life Insurance on Your Kids?

There are a few reasons why carrying life insurance on your kids can make sense.  Among these are (1) inability to afford a proper funeral should they pre-decease you, (2) desire to preserve your child's insurability, or (3) desire to 'set them up for life'.  In this post, we'll answer the question and as you will see, much depends on your financial circumstances.

Funeral Expenses

It is a terrible, terrible thing when a child dies at a young age.  Beyond the emotional toll that lasts a lifetime, there is also a financial ingredient as very few of us have a plan to pay for the funeral of a child.  Often, memorial funds are setup at banks so family, friends, and the community can help pay for these expenses, but there is no guarantee that these contributions will match the high costs of a funeral.

For this reason, it is a good idea to purchase some form of life insurance on your children.  The chances of this kind of tragedy striking are incredibly low, and consequently, insurance premiums are very inexpensive.  Generally speaking, a policy can be had for only a couple of dollars per month through group life insurance from an employer or as a rider (add-on) to an individual life insurance policy.  Either way, it's worth investing a few dollars a month to make sure you're covered if you don't have the money availble to pay these expenses.

Preserving Insurability

Many of us have family medical histories that will make it difficult for our children to obtain life insurance when they need it.  To remedy this problem, a permanent life insurance policy can be purchased for a child that will (1) guarantee coverage, (2) lock in premium rates, and (3) increase the death benefit to keep pace with inflation.  In short, even with a poor family medical history, insurance can be procured to assure them of coverage later in life.

'Setting Them Up for Life'

If you are wealthy and want to help your kids become wealthy too, a max-funded permanent life insurance policy can be used to accomplish your goals.  With a permanent life insurance policy, you'll give your kids a great deal of financial flexibility that will allow them to take out a loan at favorable interest rates, preserve their insurability, and provide an asset that could be used in starting a business, going to college, or even retiring comfortably.

NOTE: We typically do not find this last reason attractive as it often backfires with children living 'soft' lives and squandering these funds more often than not.  Research suggests money given is far less valuable than money earned.

Wrapping Up

Of the three main reasons why you should buy life insurance on your child, the first is the most common.  The simple fact is that most of us don't have sufficient money set aside to cover the cost of a child's funeral.  Beyond that, special cases such as preserving insurability or setting up a child for life can be valid reasons, but are much less common.  The bottom line is you should always carry insurance for large losses that you otherwise cannot afford.  In this instance, it's a few dollars each month to offset a risk that can be upwards of $10,000.

Critical Thinking

• Having a child pre-decease you is one of the worst things that can ever happen to a person.  What are the indirect costs associated with this type of event?
• Strictly from a financial perspective, what does a funeral cost?  What about any final medical bills?
• Is it worth a few dollars each month to insurance against the financial costs of this type of tragedy?
• What is the opportunity cost of buying this kind of insurance?  How many hamburgers, fries, or soft drinks does it equate to?

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Pricing Anomaly - When One-Off Prepaid Phones Beat the Big Boys and Save You Money

In researching mobile phone options, a surprising anomaly came to our attention - prepaid mobile phone plans were significantly less expensive than those offered by larger carriers.  Keep in mind that we weren't just looking at talk time, rather, we were looking for the company that offered the best talk, text, and web pricing for various demographics.  While the major carriers dominated the family plans portion of the market, one-off carriers offered some eye popping savings for those on individual plans.

About One-Off Carriers

The four most well known one-off carriers are Cricket, Boost Mobile, Tracfone, and Virgin Mobile.  You may or may not recognize these names, but each offers some form of nationwide service on a prepaid basis that actually runs on one of the major carrier's networks.  In other words, these companies sell service running on much of the same hardware as what you will find from AT&T, Verizon, Sprint, or T-Mobile.

The operative word in that last sentence is 'much'.  The services offered by prepaid companies often are subservient to the services afforded their 'regular' customers.  As an example, with Sprint's 4G network, prepaid services will likely continue to run on 3G for some time to come.  Put simply, you may not get all of the latest enhancements offered by the big boys on a one-off company's service.

But...

You can save a bundle of cash.  For our comparison, we'll pick the least expensive deal that we could find on a plan from Virgin Mobile USA.  Their least expensive plan was $25 per month and included 300 minutes of talk and unlimited text and data.  Comparing similar plans, Virgin Mobile USA customers are saving a bundle over the major carriers:

Carrier	Monthly	Annual
AT&T	$44.99	$539.88
Sprint	$41.99	$503.88
T-Mobile	$34.99	$419.88
Verizon	$64.98	$779.76

In the comparisons above, we listed savings compared to similar plans.  For example, Virgin Mobile USA offers 300 minutes whereas AT&T offers 450 and T-Mobile comes with 500.  While these differences are important if you use your phone to talk quite a bit, our major concern was finding the least expensive service that still had talk, text, and web.  Based on this research, a Virgin Mobile USA customer is paying between $419.88 and $779.76 per year less than someone on a similar plan through a major network.

For Whom is Prepaid Right?

As mentioned at the outset, major carriers continue to rule in the family plan segment.  In addition, prepaid phone carriers typically offer less-than-best bells and whistles, so iPhone and Droid loyalists will need to go elsewhere.  The net result is that prepaid phone service is best suited to those that meet the following criteria:

1. Individual Plan
2. Minimal Talk Time
3. Unlimited Text
4. Unlimited Data
5. Willing to Give Up a Few Bells & Whistles
6. Want to Save Money

Wrapping Up

To be frank, we were shocked that an unlimited data plan with any voice minutes would be available for $25 per month, let alone one with nationwide coverage on a 3G network.  What this shows is that if you take the time to look carefully, you can sometimes find a pricing anomaly that you can take advantage of.  In this case, savings of up to $779.76 was found.  Not bad for 30 minutes of shopping.

NOTE:  We've road tested the Kyocera Loft phone (the least expensive option offered) with the Virgin Mobile USA plan discussed in this post.  The phone works well, connects with gmail and Facebook easily, and the service is satisfactory (not much coverage in rural areas off the interstate).

***TodayForward does not accept revenue from advertisers***

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Average College Costs for 2009-2010 from the College Board

The cost-benefit relationship of a college education continues to deteriorate as the costs associated with obtaining a degree climb at rates well above general inflation.  Compared to the price of goods as measured by the Consumer Price Index (CPI), post-secondary education costs continue to rise at rates of more than twice that of general inflation.  With this in mind, we'll take a quick look at current average costs so you can better size up your college savings goals.

College Costs for 2009-10

According to the College Board, average college education costs were:

• Private 4-year:  $26,273, up 4.4%
• Public 4-year:  $7,020, up 6.5%
• Public 2-year:  $2,544, up 7.3%
• Surcharge for Out-of-State Students:  $11,528

Projections for 2010-11

Assuming inflation rates remain the same for next year, education costs would project to be:

• Private 4-year:  $27,429
• Public 4-year:  $7,476
• Public 2-year:  $2,730

Application:  Calculating Future Costs

If you're a DIY kind of person, it's simple enough to calculate future costs of education using the base numbers given above and the following formula:

Future Cost = Cost Today * (1 + Inflation Rate) ^^{# of Years to College}

The formula above will give you the future cost of a single year of college.  To calculate for each additional year, just add one to the '# of Years to College'.  When you've finished, you'll have the total cost of a college education some number of years into the future.

Of course, most of us aren't DIY with this kind of math, so here's a nice, quick calculator from the College Board that will do the trick in about three minutes.

Wrapping Up

In making decisions related to college education, increasing costs continue to be a major concern as it makes the cost-benefit relationship less compelling - particularly for those attending school many years down the road.  While there is little doubt that degree holders enjoy higher wages and fewer bouts with unemployment, the costs of these benefits are rising at rates that could eventually lead to college being a poor trade-off.  

Already, it is debatable if some liberal arts degrees awarded by expensive private colleges and universities can ever pay for themselves.  It will be interesting to see if inflation rates for education will ever return to that of overall inflation.  If not, there will come a day when the cost-benefit relationship will no longer make sense.

Critical Thinking

• If college education costs continue to rise at twice the rate of overall inflation, will a college degree become more expensive than it is worth?
• A private college cost an average of $19,253 more than a public school or close to $80,000 more over the course of four years.  How does that affect the cost-benefit relationship?  How long would it take for the private education to match the value of a public education assuming a private school grad made $5,000 more per year than his or her public counterpart?
• Part of the college experience is going away from home and learning how to live on one's own.  Is this lesson worth the annual out-of-state surcharge of $11,528?  What about room and board?
• Financing a college education is relatively easy, but very, very expensive.  How does having to use student loans affect the value proposition of higher education?

References:  College Board Trends in College Pricing 2009

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When to Buy Permanent Life Insurance - Whole, Universal, Variable, or Variable Universal

Many advisors almost exclusively advocate purchasing term life insurance while many insurance agents continue to recommend permanent life insurance (sometimes forcibly).  Who's right?  It depends.  Term life insurance is likely the best option for most due to its temporary nature and significantly lower costs, but permanent life insurance has an important role as well.  As we'll point out in this post, whole, universal, variable, and variable universal life insurance can all be suitable policies depending on circumstances.

The Basic Rule

At the heart of all of these situations where permanent life insurance makes sense it the basic principle that if you have a permanent insurable interest (say, taking care of a special needs child), then you should purchase a permanent insurance policy.  It seems rather simple, but often, unwary individuals and families will buy a permanent policy to insure a temporary need.  This is unfortunate because permanent policies are very expensive and the added costs are not easily recouped.

I'm Rich

There is a small percentage of folks who are very wealthy and require life insurance to offset the effects of estate and inheritance taxes.  Life insurance is income tax free, and if setup properly can also escape death taxes.  Most commonly, wealthy individuals will purchase permanent life insurance of some form or another and own it within an Irrevocable Life Insurance Trust (ILIT).  With the insurance owned by an entity exempt from estate taxes, the proceeds from the policy can be paid to the beneficiaries without taking a haircut from Uncle Sam.

I Own a Successful Small Business

Most businesses don't reach higher levels of success with only one owner; they usually have two or more.  As a small business, there are two major life insurance needs that may arise in the form of insuring against the death of an owner or that of a key person whose loss would make a material impact on the business.  These issues are nearly always best handled with permanent life insurance.

In the case of an owner's death, the surviving owner(s) typically will not want to be in business with the deceased's beneficiaries so a buy-sell agreement will be used to facilitate the sale of the deceased's interest in the company.  This arrangement keeps the business functioning well because there is no interference from those unfamiliar with the company and it frees up equity to bring on a replacement in the company, if needed.  The beneficiaries receive a cash payment and can then walk away from the business altogether.

With a key man that isn't an owner, life insurance may be important to insure against the possible loss in business should the key person die unexpectedly.  These are usually executives or general managers of small businesses who have a great deal of responsibility and influence on the success or failure of the firm.  By insuring this potential for loss, the business owners are better able to provide for a stable transition from the deceased to a new key person.

I Have a Special Needs Dependent

Another important use for permanent life insurance is for the provision of funds for a special needs dependent that will need money long after the provider dies.  These are typically owned in a trust that has specific provisions associated with it, but having permanent life insurance in place ensures that money will be available to a dependent beyond the provider's lifetime.

I Am a M-I-S-E-R-A-B-L-E Saver

This last one is debatable, but we'll take a more behavioral approach to personal finance on this.  For those that simply cannot save a nickel without being forced to do so, permanent life insurance may be a way to force savings into one's life.  Make no mistake, insurance is an extremely expensive savings vehicle that will produce returns that are far below other alternatives and may even trail inflation.  However, some folks seem to be able to commit to and stay with an insurance policy better than a 401k, IRA, or savings account.  While we can only speculate, the highly inflexible provisions of permanent life contracts (like not being able to take out a dime for 15 years) and regular payment of premiums required appear to be a good combination for those that cannot save on their own.

Wrapping Up

We are major proponents of term life insurance, but permanent policies do have a place.  We've pointed out four common issues that make permanent life insurance a suitable option.  However, you should always remember the rule that permanent policies should only be used to insure permanent needs.  By the way, if you're a miserable saver and generally can't hold onto money for any length of time, the odds are good that you have a more permanent problem on your hands, thus, permanent insurance could make sense.

Shifting Resources - Save Money on Energy with an Audit

Anytime we look at cutting expenses, we're actually talking about shifting your resources from one area to another in an effort to spend less on something that gives you less satisfaction to something that will give you more.  In this post, we'll look at a simple way to save money on energy so you can take the savings and put it someplace that will serve you better.  Let's face it.  Energy is necessary to an extent, but we'd all rather spend it on vacation instead.

Home Energy Audit

The fastest and surest way to save money on energy is to conduct a home energy audit.  While you might think this would require some sort of expertise, it doesn't.  In addition, many gas and electric companies offer free home energy audits on their websites with a few even giving you some energy saving products for taking the time to do one (like energy-savings CFL bulbs).

The purpose of an energy audit is to see how you're using energy and find ways to reduce your usage.  There are many variable that include the type, size, and age of your home, what type of lighting and electronics you use as well as the energy efficiency of your appliances and heating and air conditioning.  Regardless of your particular setup, the energy audit will find ways to help you reduce your energy consumption which will, in turn, save you money.

From Your Energy Company

To find out if your energy company offers a free audit, go to Google and type in the name of your energy company followed by the words 'home energy audit' as shown above for Duke Energy.  The search results should show your company's home energy audit link on the first page.  When you see it, click through and start your online audit which should take between 5 and 15 minutes to complete.  If you can't find it, you can go to your company's website or use the one provided by the government detailed in the next paragraph.

From the U.S. Department of Energy

The DOE has a similar setup to what you'll see at an energy company's website.  One of the things that we like about this audit tool is the recommendations list the estimated payback time for any investment you'll need to make and ranks them accordingly.  It's a simple three page form, and you'll need to click on the 'Upgrade' tab and then click 'Recommendations' when you're finished to get the details.  Click here to use the DOE home energy audit tool.

How Much Will You Save?

The simple answer is 'it depends'.  When you look through the recommendations, you will see some very inexpensive or even free ways to reduce your energy consumption that will generally lead to a savings of 5% to 10% of your annual energy expenses.  However, to maximize your savings, you will often need to make some type of cash investment in upgrading appliances or making other improvements to your home.  This will be up to you as to how much you're willing to invest to save money on energy.

Our Take

What we advocate is that you take all of the 'cheap steps' to reduce your energy usage like fiddling with the thermostat, installing CFLs, turning the lights off, and generally being more aware of your energy waste.  The more significant investments generally pay for themselves over time, but we always recommend paying cash for these improvements as interest on loans (even tax deductible ones) can significantly increase the payback period and add risk to your financial life.  Either way, do the little things first and then move up to the larger ones.

What is an Economic Externality? BP's Massive Gaffe in the Gulf

The British Petroleum (NYSE:BP) oil spill is shaping up to be one of the largest environmental disasters in human history as millions of gallons of crude are spewed into the Gulf of Mexico, threatening to spread into the Atlantic and wash up on coastal areas that treasure their beaches.  While this is an environmental tragedy to be sure, it is also beginning to take a very real economic toll on the fishing and tourism industries.  As such, now is a good time to better understand economic externalities and how to prevent problems of this sort in the future.

What is an Economic Externality?

To answer this question, let's take a quick step back to understand the economy and how market participants interact.  In the case of oil, we all need it for our vehicles - oil to lubricate the engine and gasoline to make it run.  We purchase these products at service stations and pay a few dollars per gallon.  The parties involved in this business include us (consumers) and all of the people, land, and equipment that produce the gasoline (factors of production).  Anyone or anything not directly involved in the production or purchase are considered 'external' to the transaction.

The previous sentence is a layman's version of the definition, but to really answer the initial question, let's expand this into terms used by economists.  From Baumol and Blinder's Economics Principles and Policy, 11th Edition:

    "An activity is said to generate a beneficial or detrimental externality if that activity causes incidental benefits or damages to others not directly involved in the activity, and no corresponding compensation is provided to or paid by those who generate the externality."

This expands our previous definition by recognizing that no compensation is provided to or paid by the party that generates the externality.  This is an important distinction, as external parties may either receive beneficial externalities (a neighbor improves her house, increasing property values for all in the neighborhood) or detrimental externalities (a neighbor abandons his house that is later vandalized, lowering neighboring property values).

Example:  BP's Massive Gaffe in the Gulf

While smaller externalities exist and play out each and every day, the Gulf oil disaster is a very large scale look at the downside of externalities.  Not only is BP losing money from the loss of oil, but the company will also be required to pay for much of the cleanup.  However, it remains to be seen if BP will also be held responsible for losses in the fishing industry or the decline in summer tourism along the Gulf Coast.  We suspect that over the next several months or even the next few years, the external costs of this gaffe will be uncovered and be the subject of many academic papers, news articles, and books.

Wrapping Up

As Congress and the Obama Administration continue to struggle with how to handle BP's abysmal efforts, they will no doubt have a long line of injured parties seeking damages from the company.  Whether or not these parties receive any compensation will be a matter of law, but it is likely that no one will be made whole.  The problem with externalities is they exist outside of the pricing of the markets.  Until financial incentives and disincentives are put in place, we will continue to see problems like those in the Gulf occur time and again.

What is Opportunity Cost?

When we think of what something costs, the most common number that comes to mind is what's listed on the price tag.  Unfortunately, this is only the nominal cost and doesn't fully represent what we're paying for a particular product or service.  To understand what we pay for a particular item, we must also take into account what else we could do with this money.

Opportunity Cost Defined

According to Investopedia, opportunity cost can be defined as, "the cost of an alternative that must be forgone in order to pursue a certain action.  Put another way, the benefits you could have received by taking an alternative action."  We'd say that's not a bad definition, but certainly not crystal clear either.  For this reason, we'll use a couple of examples to get a better understanding.

Example:  Going Back to College

With a rapidly changing job market, many are considering going back to college to pursue a new or better career.  The cost of this is usually whatever tuition, books, and fees will amount to.  However, that's just the price tag and not the opportunity cost.  Let's consider Susan as an example.

Susan is working in an administrative capacity and earning $35,000 annually.  She would like to go back to school to obtain an undergraduate degree in business management under the belief that she would be able to move into a management position and make approximately $50,000 each year.  She will require only two years of school (she's already obtained a 2-year degree) that will cost $30,000 for tuition, books, and fees.

During this time, she will not be able work.  What is the cost of her education?

The simple answer is $30,000 for her college expenses.  However, she is also giving up working that will cost her $70,000 in lost wages.  As a result, the total opportunity cost is $100,000.

The next logical question is, "How many years will it take to get break even?"  Using relatively low interest costs and inflation, it would likely take her seven years to be as well off as if she had continued to work at her lower paying job.

Obviously, this example is dealing with rather large numbers, but what about some of the everyday choices that we make?  Do they have opportunity costs associated with them as well?

Example:  An Expensive Dinner

Kevin and his wife are foodies and spend around $400 each month eating out at fine restaurants in their area.  This is one of their favorite activities, but they're also saving exactly zero dollars each month for their five year old son's college education.  Though they've repeatedly stated that funding his education is a major priority, they have yet to set any money aside.

In this example, Kevin and his wife have placed a higher value on eating fine cuisine than on their son's college education, but what is their opportunity cost?  To determine this, we need to know what they could do in saving for college versus eating out.

The nominal cost is $400 per month, but the opportunity cost is significantly greater.  To calculate the cost of not saving for college, we would need to make some assumptions about where the money would be saved, how it would be invested, what rate of return would be achieved, what inflation would look like, and so on.  To make it simple, let's assume the following:

• $400 could be placed in a 529 plan
• A balanced investment portfolio would be used
• Average returns would be 8% annually
• The money would be invested for 13 years
• Inflation would be around 5%
• The money would be withdrawn tax free per 529 plan rules

If this is the case, over the course of one year, the opportunity cost would be $6,922 compared to the $4,800 they're spending on dinners out.  To put this as plainly as possible, their choice to eat out instead of set money aside for college costs them $6,922 each year.

Why is it so much more?  The answer to that has to do with the fact that they are spending money on something that has no value after it is spent whereas with investing money for college, the money can grow based on the investment returns.

Opportunity Cost Re-Defined

Earlier, we gave you a definition from Investopedia, but after running through these examples, let's state it in more familiar terms.  Opportunity cost is best defined as the total cost of your next best option.  We all have limited resources and virtually unlimited choice.  What you need to do is consider what something costs and how alternative choices stack up.  When it comes to buying something that has no lasting value compared to something that will grow over time, you have to really enjoy what you're buying to make up for the difference in opportunity cost.

In our examples, if Kevin and his wife are a happier couple because of their dinners out, maybe that's enough to pickup the difference in cost compared to funding college for their son.  If Susan will be made happier by going to school and quitting work, maybe it makes the seven year payback less of an issue.  The bottom line with this is we all have to make choices, but taking a serious look at opportunity costs will generally give us the best outcomes.

Wrapping Up

As we've stated earlier, the study of economics is all about maximizing our happiness and satisfaction in life.  Knowing your opportunity costs can help you make better decisions in allocating your time and money which will lead to a greater sense of happiness and satisfaction.  If you fail to count the costs, odds are good that you'll wind up feeling the pain from your choices.

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How to Avoid Paying 'Stupid Tax'

If you read the 'stupid tax' stories on DaveRamsey.com, you'll find that it comes in many shapes and sizes, but what can you do to avoid paying it?  Is there some kind of formula or set of rules you can put in place to save yourself a lot of financial grief later in life?  In this post, we'll explore answering the question of, "how to avoid paying stupid tax."

It is Inevitable

First, let's be straight about stupid tax:  you will pay stupid tax at some point in your life and it is almost guaranteed that you will do it many, many times.  With that statement, you might think trying to avoid stupid tax is a fool's errand, but the reality is that your goal should be to limit the amount of stupid tax you pay rather than completely eliminate it.  Trying to avoid it altogether will only create added frustration, so acknowledge that it is part of life and let's get moving in reducing the amount you pay over your lifetime.

Stupid Tax = Buyer's Remorse = Cognitive Dissonance

Sometimes the best method for reducing stupid tax is to consider what stupid tax really is - buyer's remorse.  Wikipedia defines buyer's remorse as "the feeling of regret after a purchase".  Sure enough, when you recognize you've paid stupid tax, you will invariably experience buyer's remorse.  This is usually followed in short order by cognitive dissonance.

While you might not be familiar with the term, cognitive dissonance occurs when you have two differing ideas in your head that you then set about to rationalize.  The problem is that once you've experienced buyer's remorse, rationalizations will abound in your mind telling you that you didn't really pay stupid tax.  Eventually, these rationalizations reach an end and you simply accept that you've done something stupid with your money.

What's great about knowing the last couple of paragraphs of information is that you have a better understanding of the psychological process of stupid tax:  (1) pay stupid tax thinking it's a good idea at the time, (2) realize that maybe it wasn't such a good idea and buyer's remorse sets in, (3) rationalize why it wasn't so 'stupid', and finally, (4) accept that stupid tax was indeed paid.  By knowing this, you'll more quickly realize when you've paid stupid tax which can help you avoid paying it in the future (How does that saying go?  Once bitten, twice shy?).

Simple Strategies to Avoid Stupid Tax

There are countless tips and tricks that could be presented here, and feel free to tell us yours in the comments section, but what we've found that works best are a few simple strategies as follows:

1. Sleep On It - when making a financial decision, take your time and sleep on it.  There are very few times when you need to make a snap decision, and putting more time between you and the decision is one of the best ways to reduce your stupid tax.  The bigger the decision, the more time you should take to consider the potential costs and benefits.
2. Inject Objectivity Ahead of Time with a Plan - most bad decisions are made in the heat of the moment and that's why our first strategy was to sleep on it.  However, there are some decisions that are very emotional in nature - e.g. buying a new home, purchasing a car, reacting to the stock market, etc.  When these bigger decisions come up, it's extremely helpful to have a plan in place ahead of time.  This means setting hard limits on what you will pay for a home or car and having an investment policy in place that details your plan when the market is hot or not.  By putting a plan in place before an emotional financial event, you'll be better served.
3. Find Your Brand of Objectivity with a Third Party Advisor - if sleeping on a decision doesn't work and you don't have a pre-fabricated plan in place for a financial decision, seek out the advice of a third party advisor that fashions your brand of values and logic.  When you're emotional, you're not the same person.  Often, we can give advice to others far better than we can counsel ourselves.  For this reason, if you're facing a major decision, it's worth taking an hour or two to consult with a third party (preferably someone with expertise like a fee-based Certified Financial Planner).
4. Expand Your Knowledge and Analytic Skills - the best, and most time consuming, way to avoid paying stupid tax is to get educated about a particular subject.  If you're looking at buying a house, it's a good investment of your time to understand real estate, the national market, your local market, and what constitutes a 'good buy'.  Realtors are famous for being crafty salespeople that play on emotions, but there is a segment of these folks that really enjoy teaching real estate.  Find one of these folks and have them teach you what you need to know before you go out to look at houses.  This is true in many areas.  Some investment advisors are salespeople, some are numbers nerds, and others are teachers.  If you learn what you need ahead of time, you'll be far less likely to do something stupid.

Wrapping Up

Again, we all pay stupid tax (this writer included), and it is very difficult to eliminate from our lives.  However, recognizing it and employing some simple strategies will ultimately reduce the amount you pay over the course of your lifetime.  How much money will these simple strategies save you?  Who knows, but even if it stops you from wasting money just once, your time reading this article will have been well spent.

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