Opportunity Cost

Loading the player...

What is an 'Opportunity Cost'

An opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%).

BREAKING DOWN 'Opportunity Cost'

1. The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages.

Here's another example: if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.).

In both cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or otherwise) with another option is the opportunity cost.

RELATED TERMS
  1. Foregone Earnings

    The difference in earnings or performance between what is actually ...
  2. Operating Cost

    Expenses associated with the maintenance and administration of ...
  3. Cost Accounting

    A type of accounting process that aims to capture a company's ...
  4. Cost Of Carry

    Costs incurred as a result of an investment position. These costs ...
  5. Economic Profit (Or Loss)

    The difference between the revenue received from the sale of ...
  6. Cost Test

    A standard test applied to a process to determine if the net ...
Related Articles
  1. Markets

    What Is Opportunity Cost And Why Does It Matter?

    Economists suggest that the "opportunity cost" of any decision, the value of the next-best alternative, is crucial to making sound choices.
  2. Managing Wealth

    Portfolio Management For The Under-30 Crowd

    Young investors have some advantages over their older counterparts. Read on to learn how to build a portfolio that will grow with you.
  3. Trading

    Reducing Risk With Options

    If you want to use leverage to your advantage, you must know how many contracts to buy.
  4. Managing Wealth

    Ten Worst Mistakes Beginner Investors Make

    Here are the ten worst mistakes beginning investors make.
  5. Managing Wealth

    Stashing Your Cash: Mattress Or Market?

    Pulling your money out of the market may help you sleep at night, but is it a smart move?
  6. Financial Advisor

    5 Questions First Time Investors Should Ask in 2016

    Learn five of the most important questions you need to ask if you are a new investor planning on starting an investment program in 2016.
  7. Retirement

    Tax Tips For the Individual Investor

    Keep more of your money in your pocket with these seven guidelines.
  8. Managing Wealth

    Getting Started In Stocks

    We'll provide a step-by-step introduction on how to invest - and succeed - in this market.
  9. Investing

    Hot or Not: Single Stocks in Your Portfolio

    It can be rewarding to invest in well-performing companies, but single stocks can present some downside for your portfolio, too. Here's why.
  10. Managing Wealth

    Why Risk-Free Investments Don't Exist

    We explain the risks inherent with all types of investments and why risk-free investments do not exist.
RELATED FAQS
  1. What is the difference between risk and opportunity cost?

    Learn the subtle differences between the concepts of risk and opportunity cost as well as how they impact your investment ... Read Answer >>
  2. What is the formula for calculating opportunity cost?

    Learn about the opportunity cost formula and how businesses use this calculation to decide between investment and capital ... Read Answer >>
  3. How does opportunity cost impact how cost of debt is evaluated?

    Learn about opportunity cost and how this concept is incorporated into the determination of the actual cost of debt capital ... Read Answer >>
  4. Why should I invest?

    One of the most compelling reasons for you to invest is the prospect of not having to work your entire life! Bottom line, ... Read Answer >>
  5. What is the difference between a sunk cost and an opportunity cost?

    Discover the difference between the sunk costs of an investment and the opportunity costs associated with the decision to ... Read Answer >>
  6. What are the key points when getting ready to file for unemployment aid?

    Before filing for unemployment aid, you must be unemployed, have worked in the past, lost the job through no your fault of ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center