Are you Factoring Opportunity Cost into your Decisions?
Opportunity Cost. Many have heard the term and have a general idea of what it is, but how often do we factor in opportunity cost into our decision-making process?
The definition of opportunity cost according to Investopedia is: The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.
Opportunity cost can be as complex or as simple as you make it. For example, if you have $500 in your possession you can do a number of things with it:
- Purchase an Xbox and games
- Get coffee for the next 100+ days
- Put it in a savings account
- Donate it to a charity
I think you get the picture. You can’t buy $500 worth of coffee and save the money. It’s impossible to do both. The opportunity cost of buying the coffee is not being able to save the money (as well as any number of alternative things you could have done with the money).
While opportunity cost is a relatively simple concept to grasp, many people don’t consider it when making decisions or deciding how to spend their time. If you go to work for a company 50+ hours a week and spend 10 hours commuting, you are sacrificing 60 hours (or more) for your weekly paycheck and benefits. This may be worth it to you, but you are also sacrificing other things that can be done with your time: building a business, going to school for a career where you will make a lot more money than you currently are, or spending time with your family. Every decision comes with sacrifices.
Sometimes people get Do It Yourself Crazy. I’m a big fan of DIY, and I have a lot of projects that I plan on completing in my house entirely through DIY methods. Some people focus so much on saving money from things like DIY that they forget something: they can use their time to increase their income and make more money.
For example: If I can make approximately $20/hour on average freelance writing and I can pay someone $10/hour to mow my lawn. The opportunity cost of me mowing the lawn is $20/hour, and therefore sacrificing my time to mow the lawn doesn’t make sense. I can spend the hour that it takes to mow the lawn to write a blog post that makes me $20, pay someone $10 to mow the lawn, and end up with a mowed lawn and $10 in profit.
There is a catch: Perhaps I value spending the time outside and I don’t mind the physical labor. It just might be worth it for me to mow the lawn myself because I get an enjoyment out of doing outdoor physical labor since I spend 60+ hours a week working in front of a computer.
Opportunity cost is not always easy to compute even in the simplest of situations. Start talking in terms of weeks, months, or years, and it becomes even murkier as to what is the most “efficient” use of your time – and of course you would have to quantify just how much you value being as efficient as possible.
Despite the difficulties that come with figuring out opportunity cost, I think it’s extremely important to consider it when making decisions. At minimum it is important to acknowledge the fact that how you decide to spend your time, energy, and money has consequences and trade-offs. Sometimes when we constantly try to save money and get Do-It-Yourself fever we miss out on potential income that could have greatly exceeded the money you would have spent on hiring out work.
Do you factor in opportunity costs when making decisions?
Photo by Danny Robinson