Definition
Opportunity Cost
Opportunity cost is the value of the next-best alternative you give up when you choose to use money (or time) one way rather than another.
Every financial choice has one. Keeping a large sum idle in a savings account carries the opportunity cost of returns it could have earned in equities; prepaying a low-interest home loan may cost the higher return that money might have made invested. Even a 'free' decision uses resources that could have done something else.
Thinking in opportunity-cost terms sharpens decisions: instead of asking only 'can I afford this?', ask 'what is the best alternative use of this rupee?'. It is also the rational antidote to the sunk cost fallacy — what matters is the best forward use of money, not what was already spent.
Related terms
- Sunk Cost FallacyThe sunk cost fallacy is the mistake of continuing with a losing investment or commitment because of the money, time or effort already spent, rather than judging it on future prospects.
- Analysis ParalysisAnalysis paralysis is when too many options and too much information leave you so overwhelmed that you delay or avoid making a financial decision.
- Time Value of MoneyThe time value of money is the principle that a rupee today is worth more than a rupee in the future, because today's rupee can be invested to earn returns.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.