Just in the heels of tax season…. Did you get a refund from the government? For most people, they have looked at a refund as ‘delayed income’ or ‘bonus’ since the IRS holds on to it until you file your taxes.  What if I told you that a refund is somewhat a loss to you. The reason is twofold: i) you gave the Government a zero-interest loan for a year ii) you have lost potential earnings had you invested some of that money yourself.  The lost potential earnings is your opportunity cost for getting a tax refund.  

Opportunity Cost?  What is it?

The word opportunity almost always has a positive connotation in any circumstance.  Webster describes it as a “‘favorable juncture of circumstances; a good chance for advancement or progress”.  We’ve all heard of the golden opportunity which Webster describes as an excellent chance to do or get something – a chance to do something that is likely to be successful and rewarding.

So if opportunity, in general, is good – why does opportunity cost then not sound like a good thing.  Let me break it down…

Opportunity Cost often comes up in finance and economics.  The first time I became aware of this term was in my economics class. This is the cost of a foregone decision.  When economists refer to opportunity cost, they mean the value of the next-highest-valued alternative use of that resource. Most of the time you will hear opportunity cost measured in terms of money just to make it simple but it is not always monetary.  For example, if you spend time and money going out to eat, you cannot spend that time at home watching TV or spend the money on something else.

From a time perspective, you can do anything but not everything – By doing one thing, you can not do something else. 

Opportunity cost in day-to-day life.

• Leaving earlier in the day to avoid traffic, the opportunity cost is the extra time you could have been snoozing.
• Just reading this article at this moment – you could have been watching TV, going for a walk, talking to a friend, etc…
• Going to the mall for shopping in place of shopping online.  The opportunity cost is the time used to travel to the mall.
• Choosing between two career choices keeping in mind that a high salary doesn’t mean a better life.  
• The choice of eating at one restaurant over another. 
• The choice of getting some rest or staying up late. 
• The choice of spending time with someone in real life or staying in and watching tv or catching up on social media. 
• Spending 10 hours learning a new skill verses 10 hours reading a book.

Opportunity cost as a HomeOwner

I recently had to paint some rooms in my house.  Now like most homeowners my first thought was it is cheaper if I DIY but over the years I have come to understand that is not always the case.  I now consider time and money when addressing home improvement projects. So I ended up paying painters to do it who finished it in a third of the time it would have taken me to do it and as the painters were painting, I went on doing another task that needed my attention that day. Win-Win!

Opportunity cost for Business Owners

In a business setting opportunity costs aka implicit costs are those costs that use a company’s internal resources without any compensation for the utilization of those resources.  When it comes to accounting for business costs, a balance sheet will reflect only explicit costs and doesn’t record implicit costs because no money is changing hands. However, it does not negate the importance of the business owner taking them into account.  For example, when a business owner chooses to work on their company without drawing a salary. The business owner’s salary is an implicit cost or the opportunity cost associated with investing their skills and talents into their business. 

Another example…

If you had the choice of investing your profits on advertising to get more business or in a new team member – which one would you choose.  Choosing to advertise could drum up a lot of business for the company but you may find that you are not adequately staffed.

As a business owner, I am constantly thinking about my limited resource – time- and constantly evaluating what is the best use of it.  The time value of money is another key consideration for a business. This can be explained by how much the value of money you spend now will bring in the future.  If what you spend now brings more in the future – now that is a good return on investment. 

Opportunity cost in Personal Finance

If you decide to take a career break, the opportunity cost becomes your lost wages.

A decision to start saving for retirement at 35 instead of 25 could mean in hundreds of thousands of dollars less thus a major impact on your future life path.  

Savings* vs Investments**:  Let’s say you have $1,000 and you have the option of putting it in your savings account or investing the money. If you choose the savings account the opportunity cost here then becomes the higher earnings you would have gained in an investment account.  

Purchase a new vehicle vs investing. Let’s say you decide to buy a new car for $40,000. That new car is likely to depreciate approximately $20,000 in the first three years.  The opportunity cost here is two-fold. Not only the $20,000 in depreciation but also you would have lost out on the compounding interest you would have earned had you invested the amount. Definitely food for thought for the next time you are considering making a big financial purchase.

When it comes to personal finances, the bottom line is to use opportunity costs to think about the long term implications of spending your money.

Two cents: there are various options/ choices to every situation, the value of foregone alternative (opportunity cost) will help you in your decision process.

The opportunity cost elevator pitch:

• When you say “yes” to a choice, you are also saying “no” to everything else that you could have done with the same money, time or whatever resource you are tagging to your choice.
• Simply put the cost of missing out on one thing because you choose another.  
• The cost of a missed opportunity.
• Opportunity cost =  return of unchosen option – return of chosen option
• What you have to give up to get what you choose
• What needs to be given up to get something.

**stock market return average

*national average for savings account is actually 0.09%