What is an opportunity cost?

An opportunity cost in personal finance is the next best choice to any decision. When making mutually exclusive financial choices it is essential to weigh the cost of not making the second best choice. Doing so will allow you to make the best choice while also understanding what you could potentially be missing.

For instance, if you've saved $10,000 and are deciding between updating your style or placing the money in a savings account with a 2% annual return, it is important to weigh the opportunity cost. By putting the money into the savings account, you would earn $200 a year just by letting it sit and grow. This passive income could be used for future purchases, emergencies, or even invested further down the line. Choosing the savings route reflects a long-term mindset, prioritizing financial security and growth over instant gratification.

On the other hand, if you decide to spend the $10,000 on updating your style, the opportunity cost is the $200 in annual interest you would have earned. While a wardrobe refresh can boost your confidence, it doesn’t provide any financial return. So, the real question becomes: is short-term satisfaction worth missing out on risk-free growth? Making this decision depends on your current financial priorities and how much you value future security versus immediate lifestyle upgrades.