Finance

Evaluating Opportunity Cost

Dan Nicholson

Every decision we make, every path we choose to pursue, and every action we commit our resources to comes with a cost. 

This cost is called opportunity cost. It’s the price we pay for the roads not taken. In our pursuit of one path, we inherently let go of the alternatives, and it’s vital to be conscious of what we’re potentially giving up. Evaluating opportunity costs is a highly individual, subjective process, but one thing remains constant – it’s deeply rooted in the value of our time.

Assessing the Value of Time

The first step in evaluating opportunity cost is placing a value on your time. This doesn't always mean translating time into a dollar value, although in certain professional contexts that might be a practical approach. The key is to understand what each unit of time means to you in relation to your ultimate objectives.

Ask yourself, "What does an hour of my time represent?" Is it an hour to spend with your family, an hour to work on your passion project, an hour to exercise, or an hour to rest and recharge?

Understanding the intrinsic value of your time, as it relates to your personal values and aspirations, is critical. This isn't a one-size-fits-all formula, and it's something you'll need to revisit and revise as your life evolves and your priorities shift.

Weighing Alternatives and Assessing Costs

Once you understand the value of your time, the next step is weighing alternatives. Every decision you make should be based on the concept of highest and best use – essentially, choosing the option that promises the greatest return based on your personal value system.

For example, let's say you have a free evening. You could use it to watch a movie, read a book, or work on a personal project. Each of these choices has a different return in terms of personal satisfaction, growth, relaxation, or progress toward a goal.

Weighing these alternatives is about more than just comparing returns; it's about considering what you're potentially giving up. This is where the concept of opportunity cost comes into play.

The Fluidity of Opportunity Cost

What makes evaluating opportunity cost challenging is its fluidity. The value we place on different activities changes based on where we are in life, our current emotional state, our goals, and even our daily mood. It's okay to allow yourself the flexibility to adjust the value of your time and the weight of your opportunity costs as your circumstances change.

Remember, understanding opportunity cost isn't about striving for perfection in every decision, but about fostering awareness of the trade-offs we're making. It's about asking yourself, "Is this choice worth what I'm potentially giving up?"

Steps for Assessment 

  1. Begin by assessing the value of your time. Write down what an hour means to you in various contexts (work, personal, health, etc.).
  1. Practice evaluating opportunity costs in small, everyday decisions first. As you grow more comfortable with the concept, start applying it to more significant decisions.
  1. Keep in mind that the process isn't static. Regularly reassess the value of your time and the opportunity costs of your decisions.

Evaluating opportunity cost is an ongoing process of learning, adapting, and making mindful decisions. By taking the time to assess the true value of your resources, you'll be better equipped to use them in a way that aligns with your most authentic desires.

Pause and Reflect 

  • Can you recall a situation where you had to weigh different opportunities and make a decision based on the highest and best use of your resources? How did you approach it?
  • How does your emotional state influence your perception of opportunity cost? 
  • How has understanding and applying the concept of opportunity cost influenced your personal life?

Dan Nicholson is the author of “Rigging the Game: How to Achieve Financial Certainty, Navigate Risk and Make Money on Your Own Terms,” deemed a best-seller by USA Today and The Wall Street Journal. In addition to founding the award-winning accounting and financial consulting firm Nth Degree CPAs, Dan has created and run multiple small businesses, including Certainty U and the Certified Certainty Advisor program.

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