1. Archive

Everyday decisions offer chance to explain opportunity cost

Your daughter wants to spend her $5 weekly allowance at the movies, but she also wants a $5 necklace she saw in the window at the toy store.

Or your college-age son is cramming for a chemistry test in his dorm room when he gets invited by friends to watch Monday Night Football.

Talk about opportunity costs.

In the often murky realm of economics, the opportunity cost of going to the movies, for example, is the necklace the child gives up. For the college student, the cost of watching Monday Night Football is likely to be a reduced grade on the test.

These costs do not refer to the actual price of one item vs. another. Your cost is what you forgo, such as the necklace or extra studying, to get what you want.

Here's the kicker: The theory is linked to the notion that you must make choices because of limited resources, such as time or money. That's true whether you're a minimum-wage worker at a fast-food restaurant or Bill Gates. (Remember, I said this is theory.)

If resources were unlimited, "there would be no costs (and) no need to forgo some things in order to get others," said John Gunn, professor emeritus of economics at Washington and Lee University.

Of all the economic concepts that I'll be exploring each month over the next year to help kids get a grasp of the dismal science, opportunity cost is one of the most fundamental. In fact, Gunn considers this principle to be "the most important single concept for people to understand about economics."

Another way to consider opportunity cost is to think about setting priorities, said Jack Jonathan, author of Yes, You Can . . . Raise Financially Aware Kids. Help your children decide what they really want and what's really important to them, he writes. A desire to be healthy, for example, is a goal that may encourage your youngsters to limit spending on snacks and instead save the money to buy a new bike or join a health club, Jonathan said.

Practically every day, opportunity knocks to explain opportunity costs to your kids. I can think of all kinds of examples:

Your daughter chooses to go to her friend's birthday party rather than go to the zoo with Mom and Dad. The cost of the party is the zoo trip she had to give up.

Your son graduated from college and you offer him a new car or a month in Europe. He chooses the car, so his cost would be the travel he passed up.

The next time your kids want you to buy them everything they lay eyes on at the mall, relax _ then smile, think about opportunity costs and start teaching.

NOT SO KID-FRIENDLY? A lot of studies cross my desk each week about savings and investing, but one in particular caught my eye recently.

It was an analysis by Standard & Poor's Corp. of the handful of mutual funds geared to teaching children about the stock market. The study included funds that allow you to set up irrevocable trusts for your kids.

The report found that the performance of this group of five funds was down an average of 3.6 percent through the first seven months of 2004. That compares with a decline of 0.92 percent for the S&P 500 over the same period.

Standard & Poor's pointed out that the performance of several of these funds also trailed their peers in 2003.

The study looked at the Columbia Young Investor Fund/Z, USAA First Start Growth Fund, Monetta Trust: Blue Chip Fund, American Century Giftrust and the Royce Fund TrustShares.

The Monetta fund was hit the hardest through July, down 11.9 percent. The Columbia Young Investor Fund, perhaps the best-known fund aimed at children, posted a decline of 1.7 percent through July.

Some of these funds offer great educational materials that teach kids about saving and investing. But when it comes to picking funds for your kids' money, performance should come first.