6 Questions to Determine Opportunity Cost

How to Know What you are Really Giving up

I first heard the term “opportunity cost” years ago. According to Investopedia, it is defined as the benefits you could have received by taking an alternative action.

For example, you could play the lottery every payday, but you’d lose the opportunity to invest that money.

Or, you could buy produce that is only organic, but you’d lose the opportunity to buy more chocolate.

Just saying.

Here are two great, slightly embarrassing, examples from my own life.

My son turned 1. He was mostly happy about this. And mostly clueless about every party ritual we subjected him to.

Wearing a traditional dol-bok worn in Korean celebration of his first birthday (his grandmother is Korean).

Still, Dontae and I cashed in our piggy bank, deciding to use it for presents.

Our nephew also turned 1, so the presents were for both of the “cousin twins”. Our coins added up to roughly $50.

There was something special about knowing how much time was spent saving those coins. And that each present was something the boys would really enjoy.

Now for the embarrassing part…

The same day I bought presents for the boys, I completely blew $50 on a cake. I mean, for all this talk of frugality and whatnot, I really tanked.

My in-laws were in town very briefly, so I skipped the homemade route and bought cakes for the party. Little smash cakes for each boy. A sheet cake for the adults.

So I guessed at what size to get, deciding on a half sheet.

It wasn’t until I was in the check out lane that I saw the price tag. $51.99!  OUCH. I thought for sure it would be half that price. At MOST. Gulp.

That cake could have fed a party 3x our size. The birthday boys didn’t even know it existed. Yes, we can give it away and freeze it, but the whole experience made me feel sick knowing how wasteful it was.

So those are two very recent, very REAL examples of opportunity cost. You can spend $50 on some meaningful, hand-selected gifts. Or you can spend $50 buying too much cake.

Opportunity Cost isn’t Always Good vs. Bad

It’s not always black or white, win or lose, right or wrong. It’s just a trade-off that needs to be monitored, otherwise, you’ll miss a lot of great opportunities.

You could spend $800 on Christmas gifts, but you would lose the opportunity to do extra travelling that year.

You could buy a new car instead of a used one, but you would lose the opportunity to be debt-free sooner.

You could spend your monthly fun money on some new shoes, but you would lose the opportunity to get a collector’s edition of an Amazing Spider-Man comic book.

I believe in my grandmother’s golden rule: S.A.T.  Stop And Think. Before your next purchase, whether it’s a gourmet coffee, pre-sale tickets to see Star Wars VII (they don’t exist, sadly), or a house, ask yourself these 6 questions:

What Opportunities am I Trading for This?

Anything you are looking at buying or doing, ask yourself what opportunities you are trading for it. Will this help me spend more time with my loved ones? Will it further my career? Will it benefit anyone besides me? If not, am I OK with that?

Is This a Need or a Want?

Wants are acceptable, but what needs am I giving up by pursuing this want? It’s ok to buy things for yourself, provided they are budgeted for. Most impulse buys are not budgeted for and tend to be a waste.

Am I Giving up What I Want in the Future for What I Want Right Now?

What are my long-term financial goals? If I said yes to this now, how would it hinder those goals? Think about this honestly and carefully. Will future you love you or hate you for this decision?

Do I Have the Money for This?

Am I giving up the opportunity to stay ahead on my payments? To live comfortably? Is this purchase worth risking that? Look at your budget, not just what is in your bank account. If this is something you have budgeted for and are ready to purchase, that is great. If not, take some time to think about it.

What is one Free Alternative to This?

Is the snack at that gas station really necessary, or can I start bringing snacks from home? Do I use my gym membership enough to justify the cost, or can I work out at home? Always think about how you might be able to get something for free or significantly cheaper.

Temptation is everywhere. Don’t give in!

How Many Hours do I Have to Work to Pay for This?

When you work out how many hours after tax you have to work to pay for something, it often changes the value. For example, if you earn $25hr and an item you want is $100, that is 4 hours you are working to pay for whatever it is you think you want. Is it worth it?

What opportunity costs have come up in your life in the last month? How did you weigh your decision?

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4 thoughts on “6 Questions to Determine Opportunity Cost

  1. Oh my gosh – I can’t count the number of times we have wasted “opportunity cost” with our money on stuff like you did with the half sheet cake. I still struggle at times with wishing we could go back and have a do-over on so many things like that. Friends, learn from our mistakes!

  2. I needed a new bed, and I did a bunch of research to find the best bed for the best price I could (I’m ok spending some good money on a bed, because I plan on having it for a long time, but still). So, I finally found my bed, found it was at Costco (great, even cheaper than I thought). Went in to buy it… and then while I was there bought a $700 grill/smoker.

    I’m not even sure it was a bad purchase, but it wasn’t a well thought out, well planned purchase, and all of my comparative shopping/research for the bed went right out the window.

    • Hahaha the power of Costco. I’ve heard you talk about getting some pretty impressive deals there, though. I’m pretty sure it’s only a matter of time before I walk out of there with a 6-person tent or an inflatable raft. 🙂