What is opportunity cost?
Our money, time and energy are limited. So choosing one thing means giving up something else. The value of the best option you gave up is the opportunity cost. It is not printed on any receipt, but it is a very real cost.
For example, spending a whole Friday afternoon with friends might have the opportunity cost of what a tuition session would have paid, or of exam revision. Hanging out is not a wrong choice; the point is to see what you gave up for it.
Say Rafi has saved Tk 5,00,000 for a wedding celebration. The real cost of a big event is not just Tk 5 lakh, but also what else that money could have done: perhaps earned something by being saved for a few years, or started a small business. Which is right depends on Rafi’s own values. Opportunity cost simply helps put the options side by side. The numbers are only an example.
Why it matters to an investor
- To see the cost of idle money: the opportunity cost of cash sitting at home or earning little is the return it could have earned elsewhere, keeping in mind differences in risk and liquidity.
- To see the real cost of a loan: when you buy something on credit, each monthly instalment is money that can no longer go into saving or investing.
- To avoid the “I won’t sell at a loss” trap: holding on to an investment that has fallen also has an opportunity cost, because that money could be working elsewhere.
- To value time: doing everything yourself versus learning or building skills, these choices carry an opportunity cost of time as well.
Compare like with like on risk
Opportunity cost is often misused: “Shares could have made 20%, so keeping money in a savings account cost me 20%.” But options with higher possible returns usually carry more risk, and the money may not be available when you need it.
So the fair comparison is with options of similar risk and similar time frame. The opportunity cost of an emergency fund should be measured against other safe, easy-to-withdraw places, not against the stock market’s best year.
What is not opportunity cost: sunk cost
Money or time already spent that cannot be recovered is called a sunk cost. It should play no part in decisions about the future, yet people often chase it.
- “I paid good money for the ticket, so I must see the film even though I’m ill”: the ticket money is gone either way; the real question is whether resting at home or sitting in the hall is better now.
- “I’ve already lost a lot on this share, so I’ll buy more to average down”: the past loss is a sunk cost. The decision should rest on what you know now, not on the price you paid before.
Opportunity cost in daily life
- Study: the cost of a master’s or professional course is not only the fee, but also the salary or experience you could have earned meanwhile.
- Buying versus renting a home: owning saves rent, but the down payment could have been earning something elsewhere.
- Your time in your own business: sitting in your own shop has no “salary” on the books, but what you could earn in a job is a real cost.
Worked example
- Say you have Tk 1,00,000 you won’t need for a year. Option A: keep it somewhere that pays 2% a year, withdrawable any time.
- Option B: somewhere similarly safe but locked for one year, paying 9% a year.
- Choosing A earns Tk 2,000; choosing B earns Tk 9,000. The difference is Tk 7,000. That is A’s opportunity cost, and in return you get the freedom to withdraw at any time.
Result: which is “right” depends on whether that freedom is worth more than Tk 7,000 to you. The numbers are only an example; tax and inflation are left out here.
Common mistakes
- Counting only the cash you pay, not the option you give up.
- Comparing a safe choice with the best result of a far riskier one and feeling you have “lost”.
- Making new decisions to win back money that is already spent (a sunk cost).
- Treating your own time as free.
With every decision, ask: “What am I giving up instead?” What you give up is part of the cost.