This article originally appeared on Trim.
If you’re ever trying to make up your mind between two equally appealing financial options, you probably have a few dependable resources to turn to: you could consult with your loved ones for advice, you could ask a mentor for insight, or, if you’re feeling really split (and totally whimsical), you could always flip a coin.
But if none of these options provides the clarity you seek, you might want to try taking a step back and assessing your options in a more objective light.
Opportunity cost helps you determine, in simple mathematical terms, what you stand to lose by picking either option. It provides a scale which you can use to quantify the values of each choice and then make a simple cost/benefit analysis.
Whether you’re trying to decide if another few years of school is right for you, find out how much saying "yes" is actually costing you or even determine whether you're ready to have another kid, opportunity cost can help you cut straight to the chase and figure out where your priorities lie.
We’ve included some guidelines on how to calculate opportunity cost, and how you can use those calculations to achieve a greater sense of clarity.
Say you’re an HR manager, and you’re trying to pick between two job offers: one is at a large international corporation, where you stand to earn $90,000 a year but might not feel completely fulfilled by the work; and the other is in the non-profit sector, at a company whose mission appeals directly to your skillset and passions, but where your annual salary will only be $60,000.
Naturally, it’s hard to pick which of the two options is right for you – does it make sense to take more money if the job is less gratifying?
If you can’t come to a clear conclusion, you can determine your opportunity cost by using a very simple formula: divide what you’ll sacrifice by what you stand to gain if you take one job over the other. So, in this instance, if you’re seriously considering the lesser-paying position at the non-profit, you’ll find that $90,000 (what’s lost) / $60,000 (what’s gained) = $1.50.
This gives you, in plain terms, the opportunity cost of taking the less lucrative position–for every dollar you’d make at the non-profit job, you could have been earning $1.50 at the other job instead.
Once you’ve calculated your opportunity cost, consider that figure and stop here – maybe that $1.50 gives you everything you need to know. If, on the other hand, you’re still uncertain, you can still go on to conduct a more detailed cost/benefit analysis.
In the case of the HR manager, the question is whether the sense of fulfillment to be gained from the non-profit job outweighs the 50 cents (or 50 percent) in wages that you’d be sacrificing. Fulfillment is obviously much harder to quantify than wages, but you can still find creative ways to conduct a cost/benefit analysis.
For instance, you could ask yourself to quantify how happy either job would make you, on a scale of 1 to 10. If you give the better-paying job a 7/10 and the non-profit job a 9/10, you can then calculate the “fulfillment opportunity cost” of taking the non-profit job by dividing 7 (what you’ll sacrifice) over 9 (what you stand to gain), giving you an answer of .78. We now know that for every unit of fulfillment you’ll gain at the non-profit job, you could be gaining .78 units at the other job.
This leaves us with two numbers: $1.50 (the financial opportunity cost) and .78 (the fulfillment opportunity cost). Assuming that money and workplace fulfillment are equally important to you, you’ll want to directly evaluate those two numbers by multiplying them together. This will create a composite opportunity cost by merging your financial and fulfillment opportunity costs into one measurement.
Based on whether your final answer is less than or greater than 1, your calculations will tell you if the opportunity costs outweigh the benefits or vice versa: in this case, 1.50 x .78 = 1.18. Because it’s greater than 1, this number tells the HR manager that the composite opportunity cost is too great to make the non-profit job worthwhile–in other words, the amount of money they stand to lose outweighs the fulfillment they’d gain.
According to this calculation, then, the HR manager would be better off taking the job at the larger corporation. It’s impossible to make meaningful life decisions just by using a simple formula, but opportunity cost and cost/benefit analyses can both be used as valuable tools in a broader decision-making process.
Whenever you’re struggling with a tough dilemma, you can use the basic formula of What’s Lost / What’s Gained = Opportunity Cost to personally weigh the pros and cons in simple, mathematical terms. And if you’re looking to apply these concepts to other parts of your financial life, alternative formulas for opportunity cost and cost/benefit analysis are being used every day to help people make more educated investments, too.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
Fabric by Gerber Life exists to help young families master their money. Our articles abide by strict editorial standards.
Information provided is general and educational in nature and is not intended to be, and should not be construed as, financial, legal, or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. We make no warranties with regard to the information or results obtained by its use, and disclaim any liability arising out of your use of, or reliance on, the information.
Fabric by Gerber Life offers a mobile experience for people on-the-go who want an easy and fast way to purchase life insurance.
UGMA accounts are custodial accounts you can use to save money or build investments for your child. Learn UGMA limits and advantages to see how this could fit into your savings plans.
College savings is easier when the whole family’s on board. Include your child in the conversation early to save and plan for their education.
When you have a baby, there’s a lot to consider. Now's the time to focus on your financial priorities. Here's where to get started.
The life insurance gender gap shows that women are less likely to have the coverage they need than men. Explore reasons and ways to close the gap.
If you have a permanent life insurance policy that has a cash value, you might be considering surrendering your policy as a source of cash. That’s a decision that shouldn’t be taken lightly.
Learning about life insurance doesn’t have to be overwhelming. Here’s how our favorite TV shows help us understand the types of life insurance.
Term Life Insurance Policy Series ICC22 2205-4004 WSA and Accelerated Death Benefit Rider policy series ICC22 2205-2623 WSA (and state variations where applicable) issued by Western-Southern Life Assurance Company, Cincinnati, OH which operates in DC and all states except NY, and distributed by Gerber Life Agency, LLC using Fabric Technologies. Gerber Life Agency, LLC is an affiliate of Gerber Life Insurance Company (est. 1967). All are members of Western & Southern Financial Group (Western & Southern). Issuance of coverage for Term Life Insurance is subject to underwriting review and approval. Please see a copy of the policy for the full terms, conditions and exclusions. Product provisions, availability, definitions and benefits may vary by state. Payment of benefits under the life insurance policy is the obligation of, and is guaranteed by, the issuing company. Guarantees are based on the claims-paying ability of the issuer. Products are backed by the full financial strength of the issuing company.
All sample pricing is based on a 30-year old F in Excellent health for the coverage amount shown and a 10-year term policy, unless otherwise stated. Gerber Life Agency, LLC (GLA) is an insurance agency licensed to sell life insurance products. GLA will receive compensation from Western-Southern Life Assurance Company for such sales. The NAIC Company Code for Western-Southern Life Assurance Company is 92622.
Western-Southern Life Assurance Company's A+ Superior A.M. Best Rating: Superior ability to meet ongoing insurance obligations (second highest of 13 ratings; rating held since June 2009). Ratings are subject to change from time to time. The ratings shown here are correct as of 09/03/2022. For more information about a particular rating or rating agency, please visit the website of the relevant agency.
Plan like a parent. is a trademark of Fabric Technologies, Inc.
Gerber Life is a registered trademark. Used under license from Société des Produits Nestlé S.A. and Gerber Products Company.
In the State of California, Gerber Life Agency, LLC is known as and does business as Gerber Life Insurance Agency, LLC.