Opportunity costs

What is opportunity cost?

Opportunity cost is the loss of the benefit that could have been enjoyed if the best alternative choice was chosen instead. Directly or indirectly, opportunity cost underpins the majority of day-to-day economic decisions that are made in society.

Because these are often unseen, opportunity costs can be easily overlooked if one is not careful. Understanding this allows for better decision-making.

Examples of opportunity cost

When making big decisions like renting vs buying a home, you will list out the pros and cons of your financial decision, but most day-to-day choices aren't made with a full understanding of the potential opportunity costs. Many people just compare the numbers by looking at their bank account to see if the monthly payment is cheaper. Often, renting will cost less in the short term compared to buying and vice versa in the long term. You may not be able to have a pet in a rental or hang a picture on the wall without approval BUT you won't have to fix the hot water heater or the roof when it leaks.

The problem comes up when you never look at what else you could do with your money or buy things without considering the lost opportunities. Having takeout for lunch occasionally can be a wise decision, especially if it gets you out of the office for a much-needed break.

However, buying fried chicken every day for the next 15 years could lead to serious missed opportunities. The biggest being living a healthier lifestyle. Next, by spending $10 per work day you will have spent $37,500 in that time frame. Assuming you invested this money well, with the average return of 10%, you could have had $79,431.

A personal example, if I choose to go out to dinner instead of cook at home, then I miss out on the opportunity to save money, have a healthier meal, and to have fun cooking with my partner in the kitchen. Focusing on the opportunity to save money: I could the money saved to invest which would grow to more over time. Focusing on a healthier meal: I could eat better, then feel better, and potentially be happier. Focusing on having fun with my partner: by ordering food, I miss out on quality time cooking together in our kitchen and having joy that this brings us.

All of these things are important, but what is more important to you at the time. There is nothing wrong with going out to eat but understand there is always an opportunity cost associated with your decision.

Opportunity costs are everywhere and occur with every decision made, big or small.