Munger Models: Opportunity Cost

My post today is about the constant consideration of opportunity cost, which is one of Charlie Munger’s “mental models” that guides all his actions. (Charlie Munger is best known as Warren Buffett’s partner at Berkshire Hathaway and the author of Poor Charlie’s Almanack, which contains descriptions of most of his models.)

There’s an opportunity cost to essentially every decision we make. For example, let’s say that I were an investor and I conducted in-depth research on three stocks: Facebook, Apple, and Netflix. If I invested $10,000 in Facebook and made a return of $1,000 in the past 12 months, the best way to assess my investment performance is not to consider only the $1,000. Rather, it is to take the return of the best performing stock that I researched but didn’t invest in (Apple or Netflix in this case) and subtract it from the $1,000. If the result is still positive, I did well. If the result is negative, I could have done better.

Another example is from my line of work. Students (and their parents) are all familiar with tuition costs and the costs of living for 1-2 years of graduate studies, but most overlook the opportunity cost of 1-2 years of foregone salary from a full-time job.

There was one memorable instance recently when one of my students received a full-time return offer from her summer internship at a major financial firm, and asked my advice on whether she should accept the job offer or still pursue a master’s degree in finance. My response: “People get a master’s degree in finance to try and get jobs like the one you’ve been offered!” In her case, with ideal job in hand, the opportunity costs for pursuing a master’s degree were just far too high.

Opportunity costs should be considered for most decisions we make every day - especially those involving money and time.

One key thing to note is to not spend too much time considering opportunity costs, because the time you spend in this way would itself have an opportunity cost - and there are many better things to do than taking overly long to make a decision. Therefore, it’s valuable to develop a heuristic, or a “measuring stick” to make decisions quickly.

For example, in the case of investing, if we know we can get at least a 5% return from term deposits with the bank, there is no need to consider lower returns or equal returns but with higher risk.

In my case, my measuring stick for deciding what I spend time on has been to ask the following whenever I'm considering to do an activity:

• Does it help me to reach financial security?
• Does it help me to nurture my relationships with people I care deeply about?
• Does it improve my health? (This was added in the past few days.)
• Does it allow me to learn something new?

If the answer is "yes" to at least one of the above, then I think it's worth doing (I explained why in this post). Only when my answer is "no" to all of the above would I need to ask a follow-up question: "Would I rather spend time doing this activity than one of the above four activities?" Nearly always, the answer is no (but I've learned to always hope for a yes - which happens to be another of Munger's models that I will cover in a subsequent post).

Below are a list of "normal" things that I've considered and now know to avoid spending time on:

• Shop alone
• Get into arguments online with people I don't know
• Check WeChat moments (朋友圈)
• Use short-form video apps (TikTok/抖音/快手)
• Get a haircut at a salon