The Cost of Opportunity
December 3, 2007
Imagine you are in the mall and you spot a pair of sneakers that you have been wanting for months are on sale for $20.00. As luck would have it that is just the amount you have available to spent. You walk back to your car thrilled that you happened to find yourself in just the right place at the right time and saved $15 to boot.
You arrive home check your messages to find your best friend has called to see if you want to go to the movies. Unfortunately, you are unable to go to the movie because you have spent the money on the sneakers.
The point to the above scenario is to illustrate that in order to obtain something we must give up something, be it money, time or as in the above scenario a trip to the movies. In the financial realm, this is defined as “opportunity cost”, which is measured not only by money but is also measured with the intangibles such as time.
Let us assume that Bob wants to purchase a new car. He reviews his budget and cannot seem to find any way to manage the cost of a new car anytime soon. However, if Bob decided to brown bag is lunch instead of going out to lunch every day the opportunity for that new car has just presented itself. Bob will have to give up going out to lunch 5 days a week at a cost of $8 per day, for a total of $40.00 per week, or $2080 per year.
Bob decides to place that $40 per week into a separate savings account with an interest rate of 5% annually (not compounded). At the end of a 5-year period Bob will have saved $10,520.00, enough for a car. Again, Bob had to sacrifice going out to lunch in order to reach his goal.
This all breaks down to making well informed and thought out decisions for your time and money. Just because something may appear to be a great deal does not always make it so. You must stop and consider what you will have to give up in order to take advantage of that great deal.
Ultimately, knowledge is your best defense when weighing the true cost of opportunity.
Posted by andry under Buying Advice |