Opportunity cost is not a fancy word from an economics class. It is an everyday decision to choose one financial decision over the other. The opportunity cost of a decision is based on what must be given up) as a result of the decision. Any decision that involves a choice between two or more options has an opportunity cost.
For the purposes of financial planning, you should look at the cost versus the benefit of each decision you make. , For example you can Rwf500, 000 on an ipod today or you could invest the same amount in a savings account. In five years, the ipod will be worth 25,000 Rfw after depreciation and the Rwf500, 000 investment will be worth Rwf650, 000 after accumulation of interest. The opportunity cost of buying an ipod is the long-term benefit that you will receive if you did not buy the ipod and invested it instead.
By carefully evaluating your alternatives and by weighing the opportunity cost of each decision, you can vastly increase your long-term wealth.
According to globally respected magazine, The Economist, opportunity cost of something is what you give up to get it. This includes not only the money spent in buying (or doing) the something, but also the economic benefits (UTILITY) that you did without because you bought (or did) that particular something and thus can no longer buy (or do) something else. For example, the opportunity cost of choosing to train as a lawyer is not merely the tuition fees, price of books, and so on, but also the fact that you are no longer able to spend your time holding down a salaried job or developing your skills as a footballer. These lost opportunities may represent a significant loss of utility. Going for a walk may appear to cost nothing, until you consider the opportunity forgone to use that time earning money.
The notion of opportunity cost plays a crucial part in ensuring that resources are indeed being used efficiently. From the above example, you can see that opportunity cost is not purely about money. The concept of opportunity cost has a wide range of applications including time management, or career choice.
Decision making is a daunting challenge – not between good and bad but within good and better and the difference can most of the time boil down to opportunity cost of each choice.