In my previous article The Cost of Ownership (which I highly recommend reading prior to reading this article) I discussed the cost of ownership. Sure you pay an explicit price to acquire something, but there are ambiguous costs to everything. The costs I am referring to are opportunity costs. As mentioned in my last post, we all suffer from three factors that prevent us from letting go. Those factors include: status quo bias, the endowment effect, and mere ownership. In summary, we are bias towards maintaining our current state when presented with other options, we overvalue our possessions more than others simply because they’re ours, and by simply touching something we feel a sense of ownership towards it. Anyone who has taken a basic economic course knows what opportunity costs are. An opportunity cost is the benefit or gain that we give up when we make a decision. It is what you must forgo in order to obtain something. For example; if you decide to spend your bonus on a vacation instead of buying new furniture, the opportunity cost is the joy that having new furniture in your home would bring you. While we often weigh the benefit of two alternatives when making a decision, we don’t always account for the underlining costs. The vacation you took will provide you with fond memories for the rest of your life while the furniture will bring you joy for about 10 years. The true underlining cost is our tendency to overvalue possessions. While it is ok to value a memory or an experience, it is not beneficial to objectify that value into a product. When it comes time for us to sell the furniture we bought, we will more than likely place a price tag on it that is well beyond it’s true worth. This provides us with a new opportunity cost that is so often overlooked or not thought about at all. The opportunity cost of obtaining something is easy to gauge, however, the opportunity cost of holding on to something is rarely analyzed in a cognitive state. In this article, I will help bring to light some key factors that will benefit you in the process of letting go.
In the world of economics there is a theory called the Law of Diminishing Marginal Utility. This theory states that as a person increases consumption of a product, while keeping consumption of other products the same, there is a decline in marginal utility that a person gains from consuming each additional unit. To break it down, the more you consume a product the less satisfied you will become with each additional use of that product. Say you and a few friends go out for dinner at your favorite sports bar. You are absolutely starving and this place has the best hot wings in town. The waiter comes to take your order and without hesitation you order 20 wings for yourself. Your friends all laugh at you and tell you that your eyes are bigger than your stomach, but you haven’t eaten all day and are sure you can eat all 20 wings with no problem. The waiter brings your wings and your mouth instantly begins to water as you smell the hot sauce that’s smothering the chicken. The first wing you eat is the best wing you have ever had. This wing is the optimal utility because you gain the most joy from it. The second wing is great, almost as good as the first. Each wing you eat you become more and more full. By the 10th wing you are no longer hungry but decide to continue eating. Each wing you eat from this point on will present you with negative utility. It no longer brings you joy to eat them and after 13 wings you begin to feel sick and bloated. The ideal serving size for you would have been 10 wings. This is because you still gained utility with each wing until after the 10th when you began to have a negative experience.
This same concept should apply to everything you own. Once you have maximized the utility of the product and it no longer brings you joy or serves a purpose, it is time to move on and let go. This is a rule that minimalist live by and a rule that brings them optimal utility of everything they own. While I’m not asking you to become a minimalist, I am suggesting that you re-evaluate everything in your life. We all have our daily routines that we carry out without stopping and evaluating possible alternatives. Sure the first time you had that Vente White Mocha from Starbucks it was an amazing experience. So much so that you began buying one a few times a week. It soon became part of your morning routine and you now consume one a day. However, have you stopped and questioned the utility that you are gaining everyday by stopping by Starbucks? By now, according to the Law of Diminishing Marginal Utility, the benefit you get from drinking this coffee becomes less and less every time. There are several possible alternatives available and at a much cheaper price. To be a bit extreme, by cutting this purchase out of your daily routine, you could save $35 per week, $140 per month, or $1,680 per year assuming you spend an average of $5 each visit. The opportunity cost of each coffee should be considered carefully. But why is it so hard for us to give up habits? Why is it so difficult to let go?
Let’s look at the Law of Diminishing Marginal Utility from a different angle. The diminishing marginal utility of wealth is a great example and states that as our income increases, the amount of satisfaction we get decreases accordingly with each marginal increase of income. For example, right now a $100,000 bonus would give you tons of happiness. However, if you are Bill Gates it almost goes unnoticed.
This graph was a byproduct of economic theory and makes total sense in a perfect, economical world, However it fails to include human behavior and emotions. Behavioral economics pioneers David Kahneman and Amos Tversky agreed that the table was a good foundation, but decided that they should focus not on levels of wealth, but changes in wealth as highlighted in Richard H. Thaler’s book “MisBehaving.” After a few changes and some additions to the table, Kahneman and Tversky came up with this:
This was labeled the Value Function and recognizes a key human behavioral trait, loss aversion. As you can see in the graph, losing something hurts us twice as much as gaining something makes us feel good. This perfectly illustrates the Endowment Effect and explains why it is so hard for us to let go of things. Whether it be people in our lives that no longer serve a purpose or a routine you have that no longer benefits you, it is vital to our happiness that we let go. Replacing your Starbucks with coffee made at home is so difficult to do because giving up that Vente White Mocha hurts twice as much and we will enjoy our home brewed coffee. It is important to realize that by letting this affect you, you are looking at your daily decisions on a micro level and not seeing the bigger picture. Sure giving up that pointless relationship that is going nowhere is going to sting, but only because it is in your human nature to fear loss. Avoiding loss will not bring happiness to your life. You may feel ok with holding on to something longer than you should, but the opportunity cost is exponential.
I challenge you to evaluate the utility or happiness you gain from your daily routines and from your possessions. Go through your closest, when was the last time you wore most of those clothes? You don’t wear them anymore because you have maximized their utility. The same with that friend from high school that you are no longer close with but you take time out of your week to meet up with them for coffee. The next time you are making a decision and evaluating opportunity costs, do not fail to account for the benefit of letting go.
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