Author Topic: How would you calculate lost earning potential? (Opportunity Cost)  (Read 4428 times)

shizzle01

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How would you calculate lost earning potential? (Opportunity Cost)
« on: September 29, 2012, 01:12:41 PM »
Hello fellow forum members,

this is my first post. And I have a question that has been in my mind since I read it in another forum:

What is the "correct" way of calculating lost (or foregone) earning potential?

a). Using an average or assumed job starter salary? (Considering raises or simply a more static wage.)
b). Using my actual year 1-x year salary in retrospect?
c). Neither, but actually discounting the lost earning potential of my last 1-n years of work, i.e. the "most productive" (highest income) years? Such an income is obviously extremly random, as I am still young.

To be honest I spent way too long in the academic university system and am still in it, so I assume my lost income due to over five years of "useless" studying and other unfortunate incidents, that I already lost at least $250.000 USD, assuming I average a salary of $50.000 in a 0815 business (administration) job over this time.

What do you think? For me this lost money is additional motivation to be financially disciplined and earn it "back", but if someone tells me I already lost $150.000 x 5 = $750.000 * or more, considering my five last work years before retirement, it actually sounds extremely depressing. But logically, it makes sense.

* which is more than all of my families financial assets at this point in time, as far as I calculated...

Why do I say lost 5+ years, even though the average graduate studies 4 years? Because I still have 2 years to go, which means, at a total of 7+ years or so, I can congratulate myself on messing up big time.

Please be kind, it's my first post here and I'm already very honest.

Cheers
« Last Edit: September 30, 2012, 04:57:38 PM by shizzle01 »

Zaga

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Re: How would you calculate lost earning potential? (Opportunity Cost)
« Reply #1 on: September 29, 2012, 02:53:14 PM »
I try very hard not to think of the past like that.  It's happened and all I can impact is the present and the future.  Yes, I have "wasted" lots of years, mostly in low paying jobs and even one year where I didn't work at all.  But I can't beat myself up about it, life's too short!

arebelspy

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Re: How would you calculate lost earning potential? (Opportunity Cost)
« Reply #2 on: September 29, 2012, 04:04:29 PM »
Agree with Zaga.  What exactly are you trying to accomplish with this number, or what do you want to use it for?

I'd argue there's much better motivational numbers, and looking at what could have been doesn't help too often.

Why do you want to calculate lost earning portential?
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Rev

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Re: How would you calculate lost earning potential? (Opportunity Cost)
« Reply #3 on: September 29, 2012, 04:13:30 PM »
First thing first, you are running into something called the sunk cost fallacy. What is done is done, and when making decisions you cannot turn back time: it often is not useful to worry about it.

Of course, I’m still happy to help you do this! There are a few things you have to take into account here, some of them industry (salary) and country (tax) specific, but it is likely not as bad as you are thinking. As you say in your post, it is hard to determine differences between salary levels of a whole career- when I do it I look at payscale or a similar site, and use the differences in median income between two positions. The purest form of calculating opportunity cost is to compare the costs of one course of action to another. You need two numbers, what you make now, extrapolated into the future, and then what you could have made. I would do it like so:

Current course of action= [Sum of Income for all 7 years (income-expenses and loans)]-[Taxes (if not already in expenses- depending on what country you live in this can be hugely different case to case- While I was in school I often had income through taxes instead of having to pay anything.)]+[Difference in income between salary of non-degreed job and degreed job for however many years you are planning on working. If you follow the way of the mustache, you are allowed to compound this, as you will be using it to grow your magnificent mustache)

Next best course of action= [Likely salary for 7 years – likely expenses]- [probably higher taxes]+ [Again, if you were likely to have invested savings, you can add the interest here.)

Subtract the next best course of action from the current course, and you find the opportunity cost of choosing what you chose.

As someone who is just finishing school themselves, part of the reason I went is to raise my wage level. I am an accountant, and once I have my ‘stache filled up, I can work part time during the tax season and make what I need for a whole year (about what I would have made if I had kept in customer service working a whole year) and let my savings compound without needing to draw on them. Being financially independent is very important to me, but I honestly enjoy my work, and working a seasonal job sounds great to me.

Rev

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Re: How would you calculate lost earning potential? (Opportunity Cost)
« Reply #4 on: September 29, 2012, 04:20:09 PM »
As you can see from my answer above, I think it is important to include your future wages, as the picture is incomplete without them. You may be pleasantly surprised. I honestly think that a better calculation is to do a oppertunity cost calculation from the point of time you are in now, as opposed to the past, and I doubt you will have cause not to move forward with the degree. Your almost there! The time you have spent up until now has not been useless, unless you have been frozen in carbonite a la Han Solo the whole time.

shizzle01

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Re: How would you calculate lost earning potential? (Opportunity Cost)
« Reply #5 on: September 30, 2012, 04:56:59 PM »
Hi guys,

thanks for your answer! Sorry for the late reply, my e-mail forwarding doesn't seem to work.

For Rev: Sure, of course I don't plan on giving up, I am very much inclined to move forward !
(More on that in another thread soon ...)

Thanks again - and yes, the financial point of view is a very negative one (and doesn't consider "sunk cost" - which I personally consider though, because I also can't just tell my bank it's "sunk cost" what I spent LOL, I still have to pay off my credit card. :P), but I was indeed just simply curious about if I would calculate it, how would I proceed?

For me it is more of a motivation to save and work harder, even if it might sound harsh for some. ;)