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?
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Photo by Danny Robinson
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I used to have a cleaning lady when I was living in the UK, because I was working three jobs and my free time was worth way more than the weekly cleaning fee. Now that I have lots of time in my hands I don’t value that so much. And you are right that one needs to factor enjoyment. I love making pizza from scratch with delicious ingredients and wouldn’t spend less on industrial pizza for the world!
@RFIndependence I think you have this opportunity cost thing down!
I agree that many don’t factor in opportunity cost when making decisions. I think many times we as people are either caught up with the moment or doing what we want. Opportunity cost can be a great thing, as long as you’re using it wisely. You’re right in that it can become murkier the longer out you project, which is part of why I think it can be so often a challenge to take in mind.
@FrugalRules I think the more you can project out opportunity cost, the more useful it is. I used a very simple scenario in this post, but one could argue the opportunity cost of getting a law degree at a top school far outweigh anything else you could be doing. Also one could argue that working full-time at trying to make a full-time income would be a much worthier trade-off than working the 9-5 grind at a corporation.
I definitely factor in opportunity costs in my decisions, this is probably because with my undergradute business degrees and my MBA, opportunity cost is deeply engrained into the majors.
@SenseofCents That’s great!
Ah, but you have to actually earn that money while the dude is mowing the yard. Can’t watch footbal instead. Although if watching football recharges you to be more productive later, it is worth hiring the gardner.
@Eyesonthedollar You could watch football instead if you value watching football more than the amount you have to pay someone to mow the yard ;)
Good post! I definitely do factor in opportunity cost but I had never thought of it that way. For instance, I can pay someone 20 bucks on a saturday to mow my lawn or I can spend 2 hours doing it. I would rather pay someone and spend that time with my kids. Am I making money by spending time with my kids? No, but my time with them is literally priceless.
@Holly at ClubThrifty I think opportunity cost comes into play a lot more with kids. The time with them is valuable, but so is providing them with the best opportunities in life (which unfortunately but not surprisingly cost money!)
gbgorr great article, you stole my Thunder. I have had this idea in my head and a draft on my blog for awhile. You beat me to the punch.
@gbgorr gbgorr Hey there is always room for more opinions in the conversation!
David, good thing you get it :) Some people don’t think about that sort of thing. I learned about opportunity cost (without knowing the actual definition / term) by being self-employed for some time. It got so important for me to figure out how much i’d be losing if I left home, that at one point I couldn’t leave even if I wanted to (because I’d be losing quite a bit of money). You can imagine how my fridge looked those days – empty.
Opportunity costs play a huge role when I am looking at a home improvement project.
@sethA Home Improvement was one of the main things on my mind while I was writing this post. So many people say “oh well you could actually do this relatively easily if you just spent some time on it.” Well sometimes it’s not worth spending 1000 hours learning how to do some sort of renovation and then actually doing it! That’s my opinion at least.
I think I factor in the opportunity cost when making decisions, and to a degree it’s almost subconscious for me at this point. I used to do a lot more video gaming, but in the end I never really had anything that came out of it except a bigger xbox gamerscore. Now when I get the hankering for some video games I tend to think about how I could be better using that time to create or maximize income streams on my sites, or how I could be making money from some other stream. Of course, I still play a random game here or there, but nowhere near as much.
Of course sometimes the intangible or relational benefits outweigh the financial cost when it comes to spending time with my family, or making time for church or for quiet time.
@moneymatters I definitely agree with you on this one. I have slowly dropped off from gaming over the years, to the point where the only game I really play is Madden. I still get urges to play but there is so many other things I would rather do with my time than play video games, such as the things you mentioned.
Nicely summarised DC! Although I agree a lot of people understand the concept, they don’t understand the implications. Opportunity cost of time is the big one – so many people take overtime to provide more for their kids (i.e. so they have more money to spend on them) when really, they sacrifice the time they could be bonding with them. It all comes down to priorities!
@SavvyScot1 I definitely agree. I think pursuing a higher-income job is usually a beneficial thing, especially when you factor in children. Making $30/hour at a corporate job sure beats working 3 part time jobs that pay the same. Might take some sacrifice, but in the long-run it might provide thousands of more hours with the same income!
Great post! Yes I think it’s almost automatic for the both of us no matter what we do whether it’s DIY or working overtime. Factoring in time is always the biggie for us so if time and money aren’t jiving.. then neither are we. Mr.CBB
@CanadianBudgetB That’s great! I hope to make factoring in opportunity cost a more automatic part of my thought process.
Opportunity cost is figured in during some times and not during others. I guess it depends on what I’m factoring for. Congrats on your Alexa going sub 150k
I’m definitely a proponent of trying to do things yourself where possible. For me, the satisfaction of doing it myself is part of the reason I do it – it also normally means that you have to work less to achieve the same outcomes because you need a lower income to provide the same standard of living. The trade off is your time spent on the job. Your point about making more money doing other things is a good one, but you have to actually do it to make the trade worth it! I hear so many people say “my time is worth more than $10 an hour” to justify things like not doing the lawn, and then do no extra work in their spare time to make up for it.
This sort of thinking gets people to outsource way more than they should without the necessary corresponding increase in income.
Time is money I think the say was because of this only. What say folks? However pursuing a business degree online can be helpful in earning more money which you can learn more about here: http://www.edegreeusa.com/program-business.aspx