Most people are keenly aware of the need to save more money. You may have real concerns about enjoying retirement, helping to care for elderly parents, adjusting to the rising cost of healthcare, and many others. Therefore, you understand that losing money hurts your balance sheet and jeopardizes your financial stability. Unfortunately, what many people do not realize is the extent to which it can.

Cost #1: The Out-of-Pocket Outlay

When you incur an expense, you usually see what is obvious… the dollars that leave your pocket. You pay for dinner out with friends and you leave cash on the table; you lease a car and submit payment for that every month; you buy a new shirt with your credit card and pay the bill at the end of the month. These are all examples of dollars that you possess that subsequently leave your pocket. Therefore, the total cost of an expense is usually measured in those terms. What you may fail to see is that the Real Cost of Living™ can be far greater. In fact, there are three costs that you incur when you give money away and take it off your balance sheet:

1. The out-of-pocket outlay, as described above
2. The time value of money cost
3. The loss of potential retirement income

A successful retirement is defined as one that provides you with sufficient assets and cash flow to achieve your income, lifestyle, and legacy objectives. Though you cannot predict the future, you need to prepare for what is probable, and still protect against what is possible.

What is probable?

A healthy couple approaching retirement age (let’s call that 65) has a 50/50 chance that one of them will live to be age 95. Knowing this at 40 years old can help you make better cash flow decisions about how much you spend and how much you save. Let’s take a look at the impact of various cash flow decisions if there was 25 years left to retire. If you paid for college for your son at the rate of $50,000 per year, the first cost is the actual out-of-pocket outlay for the expenses of tuition, fees, etc. – $200,000 in total. In this example, there is no return of or return on that money.

Cost #2: The Time Value of Money

There is a second cost that most people don’t measure. Every time you lose a dollar, you lose not just that dollar, but everything that dollar could have become for you if you had saved or invested it. That is, if it were earning a rate of return, it may have grown into something greater than the $200,000 out-of-pocket outlay. We refer to this as the cost of the Time Value of Money (TVOM). Loosely described, this is an opportunity cost. It’s a way of measuring the cost not only of money that leaves your wallet, but also the cost of money that never gets the opportunity to get into your wallet. The way we measure the TVOM is by saying the following: Consider that the rate of return on a dollar that is lost is not 0%. In fact, it’s worse… it’s -100%. The loss of it is not a risk; it is a guarantee. So, if you can develop a strategy that allows for a reduction or elimination of that expense, and if you can find an asset somewhere on your balance sheet that carries a better than -100% return, then you should be able to put those savings into that asset and have more money on your balance sheet. For this purposes, the TVOM rate is described as being the best after-tax return that is available to you. In this example, it might be that your 401(k) is providing a long-term rate of return of 8% pre-tax. If you net that out for taxes, then that might mean an aftertax return of 5%. So then, if you could have held on to those assets, by retirement you’d have not only the assets you gave away for college, but an additional $206,000 on your balance. Therefore, the payment of tuition, etc., really cost you $406,000 that could have been on your balance sheet at retirement.

Cost #3: The Loss of Potential Retirement Income

At 65, by not having that $406,000 on your balance sheet, and not being able to earn a modest return during retirement (let’s say 5%), you forego potentially as much as $20,000 per year in retirement income if you spent the income only, or as much as $31,000 per year if you chose to annuitize that over your lifetime, guaranteed never to run out for as long as you live!¹ And that’s just the cost of college. When you begin to compile all the areas where you incur costs, the numbers can become astounding. Clearly, not all costs can be avoided. Some costs such as certain taxes and insurance premiums, are ones that need to be paid in order to avoid adverse consequences, financial or otherwise. However, you need to think differently about how to mitigate the impact of the costs you incur. And while there has been an entire industry that has risen out of the need to help parents plan and save for college, few people are talking about how to help you not just save for college, but measure the true cost of it, then devise a strategy to recover that cost.