money

How To Calculate Opportunity Cost: The Hidden Cost Of Every Decision

Amy Blacklock

WealthFit Contributor

You make dozens of decisions daily—you even make a few before you get out of bed in the morning. Some of those decisions are made out of habit, some are carefully considered, and others are made in the spur of the moment.

Whether you spend 10 seconds or 10 days weighing a decision, each one comes with strings attached.

With each option you choose, you’re saying “no” to a different option. The value of what you do not select is called your opportunity cost.

You can think of it as the value of what could have been.

Understanding opportunity cost is a crucial part of getting an investor education.

Opportunity Cost (The Obvious Costs)

Opportunity cost plays a major role in your personal finances.

How you spend your resources corresponds directly with how successful you’ll be in your wealth building activities.

Spending money on a new sports car means you can’t invest that money in real estate or a stock portfolio.

The same $500 can’t be invested in your child’s college savings account and your IRA at the same time.

Choices need to be made.

For example, if you choose to invest $500 into a savings account for your newborn baby, it has approximately 18 years to grow with compounding interest for their first year of college.

That same $500 invested in your retirement savings account would have maybe 25 years to build for your retirement.

So, the opportunity cost of investing $500 for college is the potential growth of the $500 if invested in your IRA.

Similarly, choosing to spend $10,000 on furniture and appliances for your new home goes beyond just spending $10,000 of your cash—you’re giving up the ability to apply it to your home’s down payment, which would save you thousands of dollars on interest costs over the term of your mortgage.

The total cost difference between a $200k and $190k 30-year mortgage at 4.5% interest is $18,240. So, the opportunity cost of buying new furnishings instead of buying a lower mortgage is $18,240 over the life of the loan.

But let’s not stop there. What if instead of a 30-year mortgage you chose a 15-year mortgage at 4%?  

The difference in interest between a $200K and $190K loan is only $13,315. But what about the opportunity cost?

The opportunity cost of choosing $10,000 in new furnishings and the 190K mortgage over the 30-year $200K is $111,840.

That’s huge.

Or let’s say you were torn between making a car down payment of $10,000 or investing that same $10,000 into an index fund.

Well, that down payment on a car would leave you down $10,000 (but up one car!) Meanwhile, if you were to invest that $10,000 into an index fund with an annualized growth rate of 9.8%, it would become a whopping $25,470 in years.

If you buy the car, your opportunity cost is all the money you could’ve made investing—nearly $15,000! That’s over twice your initial investment in spendable or investable passive income. If you decide to invest, your opportunity cost is a set of wheels.

Which would you choose?

Opportunity Cost (The Not-So-Obvious Costs)

It’s important to consider more than just the financial implications of a decision.

Perhaps you really do need a new stove, refrigerator, and sofa. It’s essential that you consider the psychological and unseen values of your choices.

Will dealing with a broken stove or faulty refrigerator cost you more in time and money later?

Will your dirty, broken down couch impact your health and relationships?

Other Examples of Opportunity Cost

Have you ever been out shopping for one thing and ended up coming home not only with that thing and another item you saw on sale?

The next time you face a similar ‘sale’ situation, consider the opportunity cost first—before you purchase the big sale item.

While it may not stop you from blowing $20 on a quesadilla maker or hundreds of dollars on a flat screen TV, it will help you to understand what you are giving up (e.g. a $20 book to improve your knowledge, a $300 course to learn a skill you can capitalize on or savings for your next vacation).

Wait . . . Free Isn’t Free?

Even free items have opportunity costs. They can take up space, cause clutter, distract you from a bigger goal, affect your health, or cost you more money in maintenance down the line.

Take the ever so popular “free to a good home” scenario used by animal shelters. That little puppy or kitten doesn’t require an exchange of cash, but it sure does come with many costs. What opportunities would you be giving up paying for the lifelong expenses of a “free” pet?

If having a pet in your life is important, then the benefits of a dog or cat will probably outweigh the expense and time requirement. Just be sure you consider all the costs before committing.

The opportunity cost of a “free” puppy could be thousands of dollars—but that’s more than worth it if you decide that “having a puppy is priceless.”

Opportunity Cost & You

It can be easy to determine the financial opportunity cost of a situation with a calculator in hand. However, it’s important to remember the additional non-monetary costs of a decision as well.

When choosing one option over another, any lost time, energy, health, or pleasure is just as much a part of your opportunity cost as money.

Opportunity cost isn’t cut and dry. It varies from person to person. We all value things differently, even time and money. The opportunity cost of a decision you make will likely be different than it would be for your friends and family.

At the end of the day, you are in charge of how you spend and invest your money and your moments. Use the concept of opportunity cost to achieve what brings you and your family the most wealth, productivity, and happiness possible.

Share

Written By

Amy Blacklock

Amy Blacklock is the co-founder of the websites Women Who Money and Women's Money Talk, and the founder and blogger behind Life Zemplified.

Read more about Amy

RELATED TRAINING

 in 

MONEY

article
How Do Annuities Work?

Learn everything you need to know about this investment option — including why probably shouldn’t buy one.

How Do Annuities Work?

Amy Blacklock

Read Now
article
Credit Card APR—Everything You Need To Know

Discover everything you need to know about Credit Card Annual Percentage Rates (APR). Plus, learn how to calculate your interest payments.

Credit Card APR—Everything You Need To Know

Amy Blacklock

Read Now
article
11 Rules For Marrying Someone With Student Loan Debt

Learn 11 rules to follow when marrying someone with student loan debt. Don’t let debt ruin your relationship—work towards a debt-free future.

11 Rules For Marrying Someone With Student Loan Debt

Amy Blacklock

Read Now
article
The Ultimate List Of Tax-Advantaged Accounts

Learn how to use 12 different accounts to grow your savings and guard against taxes.

The Ultimate List Of Tax-Advantaged Accounts

Amy Blacklock

Read Now
article
How To Immediately Lower Your Cell Phone Bill

Odds are you’re overpaying for your cell phone BIG TIME. Learn how to get that bill lowered in just a few steps.

How To Immediately Lower Your Cell Phone Bill

Amy Blacklock

Read Now
article
Credit Cards for Kids: How to Jump-Start Your Kid’s Credit Score

The earlier your children learn to responsibly use and build credit, the better. Learn how to jump-start your kid's financial future with a credit card.

Credit Cards for Kids: How to Jump-Start Your Kid’s Credit Score

Amy Blacklock

Read Now
article
Your Battle Against Time: How to Conquer Inflation & Rescue Your Retirement Plan

Did you know that inflation can actually ruin your retirement? Here are 6 smart ways you can protect your retirement from inflation.

Your Battle Against Time: How to Conquer Inflation & Rescue Your Retirement Plan

Amy Blacklock

Read Now
article
The Magic of Stock Index Funds: How To Consistently Grow Your Retirement Fund [With Less Risk]

To most people the stock market feels like gambling. But stock index funds have consistently outperformed most actively managed funds.

The Magic of Stock Index Funds: How To Consistently Grow Your Retirement Fund [With Less Risk]

Amy Blacklock

Read Now
live talk
Replace Yourself, Retire with Purpose & Scheduling Priorities

Dustin sits with Best Selling Author and Certified Retirement Planner, Casey Weade. Detailing the spectrum of Retirement, Casey dives into how to set effective financial goals, the rule of 100, and how to retire with purpose.

Replace Yourself, Retire with Purpose & Scheduling Priorities

live talk
Student Debt, ‘On The Side’ Income & Investing Quickstart

Robert Farrington takes us through his journey from working at Target, to hitting his target investment goals. Helping millennials get out of student loan debt and accept personal accountability for their money, his expertise is shared to help build wealth through investing.

Student Debt, ‘On The Side’ Income & Investing Quickstart

live talk
Quit Like a Millionaire

Imagine retiring in your 30's and traveling the world on permanent vacation. Kristy Shen and Bryce Leung live this lifestyle and sit down with Dustin to explain how you can do the same. By going against the norm, investing their money, and quitting their jobs, tune in as they share helpful tips from their new book, Quit Like a Millionaire.

Quit Like a Millionaire

live talk
Do You Have A Powerful Money Mindset?

Dustin sits down with Military Money Expert, Lacey Langford, as she drills the importance of getting your personal finances up to military standards, without all of the yelling. An Army brat, financial expert, military wife, and veteran all rolled into one, Lacey is on a mission to help combat the fear around money.

Do You Have A Powerful Money Mindset?

More Cashflow, Less Stress

More Cashflow, Less Stress

How To Boost Your Monthly Income By "Going With the Flow" of Wealth

Dale Gibbons

Watch Now
live talk
Master Your Money in 7 Days (or Less)

Learn the world's SIMPLEST cashflow method, how to reduce personal and business debt, and the 3 critical skills every business owner should have.

Master Your Money in 7 Days (or Less)

Master Your Cashflow

Master Your Cashflow

How To Turn Financial Chaos into Financial Peace By Taking Control of Your Cashflow

Dale Gibbons

Watch Now
Financial Adulting

Financial Adulting

The 20-Something's Guide to Debt, Investing, and a Wealthy Life

Ellen & Micah Long

Watch Now
live talk
What’s Your Money Operating System®?

Hilary Hendershott shares what really causes financial trouble and how she was able to get out of debt as a financial advisor.

What’s Your Money Operating System®?

Zero Student Debt

Zero Student Debt

How To Make a Smart College Investment and Graduate Debt-Free

Ellen Long

Watch Now
live talk
A Candid Conversation with a Private Banker

Discover more about the controversial topics about money and banking your banker probably won't talk to you about. Also, find out where the finance world is headed.

A Candid Conversation with a Private Banker

The Early Retirement Blueprint

The Early Retirement Blueprint

How To Build Wealth Faster & Accelerate Your Retirement Timeline

Tom Wheelwright

Watch Now
Pay Less Taxes

Pay Less Taxes

How To Legally Reduce Your Taxes By Up To 40%

Tom Wheelwright

Watch Now
live talk
Getting Yourself In the Flow of Wealth

Justin Faerman on the flow of creating wealth and avoiding the massive sacrifices that our parents, programming, or society expect of us.

Getting Yourself In the Flow of Wealth

The Hidden Power of Life Insurance

The Hidden Power of Life Insurance

How To Leverage Life Insurance for Financial Security & Wealth Acceleration

Stuart Arakelian

Watch Now
Money 101 for Teens

Money 101 for Teens

The Ultimate Guide To Making, Spending, Saving, and Investing Money

JP Servideo

Watch Now