Opportunity cost
The value of the best alternative you give up when you choose to spend money, time or resources one way instead of another.
What it means
Every choice rules out other options, and opportunity cost is the value of the best option you passed up. Spending $5,000 on a vacation means not putting that $5,000 toward debt, savings or investments, and the cost includes whatever those alternatives would have earned.
Opportunity cost is not a bill you pay, so it is easy to overlook. Thinking about it helps compare choices that look free or cheap on the surface, such as keeping a large cash balance in a low-interest account or taking a job with lower pay but better benefits.
Example
Suppose you spend $5,000 today instead of investing it at a hypothetical 6% annual return. After ten years that money could have grown to about $8,954, so the opportunity cost is roughly $3,954 of forgone growth on top of the original $5,000.
How it’s used
- Deciding between paying down debt and investing
- Weighing a large purchase against long-term goals
- Comparing where to keep cash, such as checking versus high-yield savings
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.