Opportunity Cost

Opportunity cost summary:  

• When you choose to do one thing instead of another, you miss out on the value of the thing you didn't choose; that value is the opportunity cost.

• Consider the opportunity cost when thinking about spending, paying debt, saving, or investing.

• Opportunity cost can clarify decision-making as it helps you compare gains against what you may miss out on. 

Opportunity cost definition and meaning

Many decisions involve some tradeoff. Opportunity cost is the value of the choice you didn't take. 

For example, if you spend $50 on a set of headphones, that's money you can't use for other things, whether it's groceries, investments, or debt repayment. Opportunity cost can help us consider what we're giving up as well as what we gain.

Key concept: When you choose one thing over another, there is a value to the opportunity you didn't choose.

More on opportunity cost 

The concept of opportunity cost can apply to money, time, and energy. To calculate opportunity cost, you need to assign value to what you're giving up, both now and in the future, for something you're about to do or buy. 

If you spent three hours of your weekend working a side hustle, that's time that you could have been using on other things, so it has an opportunity cost. On the other hand, if you choose to relax and scroll for three hours, the opportunity cost could be the money you didn't earn with a side hustle.

Key features of opportunity cost

Here are the main ideas of opportunity cost:

• Tradeoffs. Opportunity cost comes down to choices. When you choose one option, you give up the benefits of another. The opportunity cost is the value of what you didn’t choose.

• Next-best alternative. The cost represents what you would have gained if you’d taken the other path.

• Time and resources. Opportunity cost isn’t always about dollars. It can also reflect how you spend your time, energy, or effort. For example, you decide to work overtime. You give up an evening with your family, but the extra money goes toward a family vacation fund.

• Not always easy to measure. Sometimes opportunity costs are harder to put an exact number on. For example, you might spend extra money having groceries delivered, but that could give you more free time and ease your stress.

• Helps with decisions. Thinking in terms of opportunity cost encourages you to look beyond the obvious or immediate benefit and consider the bigger picture. You consider what else you could be doing with your money, time, or effort.

Real-life examples of opportunity cost

From a financial standpoint, you can calculate opportunity cost by subtracting the gains on the option you choose from the gains on the path you didn’t take. Here’s an example of opportunity cost in someone’s life:

Jordan just got a $500 bonus at work. He’s delighted—but also unsure how to use it. He’s torn between two possibilities: 

• Put it toward his emergency fund, which earns 5% interest

• Pay off a credit card, which charges 20% interest

Jordan decides to pay off the credit card. He loses the potential to earn 5% interest on his $500—that's the opportunity cost of his decision. He still comes out ahead, however, since the credit card debt had a 20% interest rate and cost him more in fees than he would have earned from his savings.