Cost-Benefit Analysis

You want to buy a house, and you have enough money for a down payment. You also want to travel around the globe. You only have two options. How do you decide? Maybe you flip a coin, but that's a heck of a way to determine your future.

Instead, you should use a cost-benefit analysis. Take out a piece of paper and write the cons (costs) and the pros (benefits) of each option.

The costs of owning a house could include a large down payment, the fact that it's an illiquid asset that can suffer large downturns in a lousy economy, the fact that you'd be living in a cul-de-sac for the rest of your life, and the fact that an agent is going to take 2% to 3% up front.

The benefits of owning a house could be access to a school district, the growth of equity, appreciation of the asset, and not burning money on rent.

The costs of traveling could include expensive trips, a decline in savings and an opportunity to build equity, the fact that you'd likely have to rent, and adjustments to your career.

The benefits of travel could include happiness, greater exposure to new cultures, all those airline miles, and the fact that you won’t have to live in a cul-de-sac for the rest of your life.

Now, that's a simple version of a cost-benefit analysis. In business, it can be a bit more complex, as analysts attempt to weigh the better of two alternative decisions. Perhaps it's the cost and benefits of two different marketing campaigns. Maybe a company is trying to decide which city to place its new office in, and needs to choose between Miami...and Topeka, Kansas.

For the guys who take it way too far, they’ll even build models that assign nominal values to each cost (negative) and benefit (positive) to score which alternative is the better one.