Opportunity cost

The hidden price tag

Every price tag shows what you pay. It doesn't show what you give up. When you spend money, time or attention on one thing, you can't use it on something else. The best of those other options is the opportunity cost of your choice.

Strictly, opportunity cost is the single best alternative you gave up, not every alternative added together. If you could have saved the money or paid down a loan, the opportunity cost is whichever of those you'd have valued most.

Sam's coffee

Sam (a made-up example) buys a $5 coffee every workday:

• $5 × 5 workdays = $25 a week
• $25 × 52 weeks = $1,300 a year (ignoring holidays and vacation)

A small daily habit becomes a four-figure yearly cost. That's easy to miss when you only see $5 at a time.

Other jobs for the money

That $1,300 could have done other jobs:

• Build savings, like an emergency fund.
• Pay down a loan, which cuts the balance and can mean paying less interest.
• Be invested, where it might grow over time. Investments are not guaranteed and can lose value, so this lesson doesn't assume any growth rate.

So the real price of the habit is the $1,300 plus what that money could have become.

Choose on purpose

None of this means never buy coffee. If the coffee is worth more to you than the other options, it's a fine choice. Opportunity cost just asks you to see the trade before you make it, instead of after.

Try it yourself

Pick one small thing you buy often. Multiply the price by how many times you buy it in a week, then by 52. Write down the yearly total and one other job that money could do for you. Then decide, on purpose, whether the habit is worth it.

Good to know

• Opportunity cost = the value of the next-best alternative given up when a choice is made (Federal Reserve Bank of St. Louis).
• It is the single best alternative, not all alternatives added together; the video lists several options as examples of what the next-best use might be.
• Sam is a made-up example with round numbers: $5 × 5 = $25 a week; $25 × 52 = $1,300 a year (ignores holidays and vacation).
• Investments are not guaranteed to grow and can lose value; no growth rate is used here.
• Opportunity cost covers time as well as money.
• The same idea works everywhere.
• Educational only, not financial advice.

Why it matters for you

Every money decision is a trade. Seeing what you give up turns spending from a habit into a choice. Next, we'll look at why your paycheck is smaller than your pay.