Without realizing it, we make hundreds of decisions every single day, professionally and personally. In the majority of cases, the opportunity cost associated with a decision is minimal. For instance, taking the scenic route home from work as opposed to the direct route will usually have trivial consequences.
However, if you were to miss out on an opportunity to bump into your favorite influencer or a high-level prospect you really wanted to meet because you walked home via the park as opposed to the main street, you incur a cost that has relatively significant consequences. This is what economists refer to as an opportunity cost.
It is often possible to quantify opportunity costs. Let’s say you make a decision between buying a slice of pizza from a fast-food restaurant or a pasta dish from a high-end restaurant.
The pizza slice costs $3, while the pasta dish costs $35. In this case, your opportunity cost is $32.
Opportunity costs can be high and can increase over time. Let’s say the scenic route home from work burns $2.50 more gas per gallon than the direct route. Over a 270-day work year, you would spend an extra $675 on gas if you were to take the scenic route home from work every day. You had the opportunity to spend that $675 on something else, perhaps a new laptop or furniture for your home office, but instead you spent it on enjoying a view.
In some cases, an opportunity cost may be offset by an alternative opportunity that emerges. For instance, if you successfully negotiate a business deal while eating pasta at the high-end restaurant, your opportunity cost of turning down the pizza is low.
However, in other cases, opportunity costs may represent inappropriate expenses. If you are struggling for cash, it may be difficult to justify spending $675 per year on the scenic route purely on the basis that you find the drive more enjoyable.
Regardless of the implications, one fact remains: Your money can’t be in two places at once.
Opportunity costs tend to become more significant when you start to make decisions about large expenses such as mortgages, car purchases or business purchases, and other major expenses. Even savings and investment decisions can have significant opportunity costs.
Let’s say you took the direct route home from work each day and saved $675 per year.
You now have a decision about what to do with this $675. You could simply keep it in a savings account and earn an interest rate of 0.05%. You won’t make much additional money on it. However, you’ll be able to get your hands on it when you need it. Alternatively, you could put the money in an IRA and get a return of maybe 5%, which will add up to much more significant sums if you continue to take the direct route home from work over many years.
So, whether you are an entrepreneur who works at home, or someone who goes to the office daily, always think about the choices you make when spending your money.