There are many situations that drive us to make many challenging decisions in different areas of our life, that have a large impact on our future. We all need to decide at times whether to worry about the downside, or take a chance, or to play it safe. When you choose one option among several other, it always happens that you miss out on a benefit that is associated with the choice you don’t make. While making decisions on a daily basis, most of us don’t fully consider the price we pay for choosing or not choosing something. And this is where knowing your opportunity costs, and trade-offs makes a difference.
Most of us struggle with myriad of choices while making some important life choices.Thoughts such as “I want to make the right decision, this is too important to mess up” and “what if I choose the wrong thing, or regret this later?” can be daunting, especially, when you are at a crossroads in your life, wondering which career option, relationship, and financial or business choices to make.
When you see so many options stretched out before you, there are always going to be some opportunities you miss out or don’t take. If you don’t consider them, you easily end up stuck in situations where you are foregoing things you’d rather prioritising. Being successful is all about understanding your opportunity costs and trade offs associated with decisions you make.
You are free to make whatever choice you want, but you are not free from the consequences of the choice.— UnknownTweet
What is opportunity cost?
In every single thing you do, you are choosing a direction. So, there is always another way to accomplish a goal you set out to accomplish. Whenever you are choosing one course of action, you are also not making or rejecting a range of other available options. And those alternatives may also have some value or prove to be of a benefit. You run the risk that another option may be faster or easier. Such foregone potential options often come at the cost of a missed opportunity.
In other words, the opportunity cost is what you give up by making a decision in favour of one choice instead of another. This foregone benefit or value related to the alternative choice when a decision is made is what is referred to as opportunity cost. And it can be different for different individuals. This is because it is determined by a person’s needs, wants, money and time. Therefore, figuring your opportunity costs is often is a better way to encourage yourself to carefully consider the range of other alternatives available to you whenever you make a decision.
What is trade-off?
A trade-off is a course of action given up in order to move forward with a different action. When there are multiple options with limited resources, we always go for the one which gives the highest benefit and forego rest of the options. For instance, if you have two hours of free time and you have to decide whether to binge watch your favourite series or to run your important errands, choosing one over the other leads to a trade-off. If you choose to run your errands, the fact that you can’t get to watch becomes your potential trade-off.
The key differences
Opportunity cost and trade-offs are two sides of the same coin. Like opportunity cost, decision-making is also all about trade-offs. However, there are some key differences. Where a trade-off is used to describe the course of action given up in order to go with a preferred option, the opportunity cost is the price you pay for opting one course of action and foregoing another opportunity.
Trade-off refers to all other alternatives which are foregone to do what you want. Whereas opportunity cost is the expected return on an investment you make with your resources, like time, money, and effort. A trade-off is what you sacrifice to an opportunity, or to get what is desired.
On the contrary, opportunity cost is what you could have done with what was sacrificed, or the benefit you receive by investing your resources in your most-valued alternative. For instance, the opportunity cost is the cost incurred as a result of choosing a project over the other. It is the alternative you give up. And trade-off refers to all other things which you could have done, apart from what you are doing.
Why are they important.
Though both are core components in making business or financial decisions, they can however be applied to other areas other than money. Everyday the decisions we make in our personal life too involve important trade-offs and do carry an opportunity cost, especially, when it comes to the pursuit of your work or personal goals.
Being successful in your goal endeavours is to get more out of your time and other resources. However, when you try to optimise one area, it is most likely that you ignore another. You have to forego one aspect to be able to invest in what is important to you. Like for instance, you might have goals in few important areas of your life like work, health, relationship, hobbies, fitness and so on. We can never keep up to everything always. It is true that focusing on priority areas often comes at the detriment of another.
So, it is always important to know your important trade-offs and opportunity costs of your daily choices. If you feel you are lagging behind or not making progress on certain things. It is probably because you are making the wrong trade-offs. The thing is that you may not be allocating your time and other resources in the way that is getting you more of what you want.
When you ignore the opportunity cost of the choices you make, you end up wasting time and attention on things that don’t matter. As a result, you either regret your choices for missing on somethings or end up taking on too much.
For instance, in the area of your work goals, if you are considering a career move, and planning on starting your own business, monetary value isn’t the only factor that is included in determining your opportunity cost. Being your own boss, work-life balance, having more freedom and time to work on your own ideas, and the extra effort needed to bring those ideas to fruition are also important in determining the opportunity cost of your decision. However, it is also more likely that sometimes it could need a stretch, you need to put in more hours, more responsibilities might lead to lack of sleep, fatigue and might end up with negative returns.
Some terms related to opportunity cost
Risk is not same as opportunity cost. While risk is the potential downside of your decision, the opportunity cost is the gain that could materialise from an alternative or choice you would go for. As you consider cost of our decisions, you choose the best opportunity to reach your goals rather than any other method or means.
However, your decision should factor on the uncertainty of gain or loss so you increase your level of risk tolerance. So, you still need to determine the risk of each option you consider or how each resource will play out.. And if you are risk-averse, or if your risk tolerance is low, you might give up on your best considered opportunities when something stretches, or when gain seems far off, or when you perceive that risk seems high.
Sunk cost may sound similar to opportunity cost, but they are not same. Many times, we consider considerable amount of resources we had already spent on a particular course of action, while calculating the cost of our decisions. Where sunk cost refers to already incurred costs in the past that cannot be recovered, opportunity cost refers to the potential future gains and are more forward looking.
Sunk costs don’t factor in while determining the opportunity cost of your decisions as they have already been spent and do not change based on decisions you make about the future.
How to consider the above factors in your decision-making
Opportunity costs in decision making show up in every area of our life. For instance, if you want to pursue a degree, which major do you choose? Or what if you choose to run family business over choosing to go to college? Do you want to invest in property now or later? What if your timing isn’t right and learned the value of the property you want to invest in goes up two years later? Here are few ways to consider while making some important decisions.
Choose how to use your resources
Choose how to use your resources when you are making personal or professional decisions. You probably want to make sure of making decision that is far more beneficial. Making decisions by calculating the opportunity cost for all the alternatives available to you is a good way to minimise wastage of your time, effort, focus and attention. To do so, evaluate the cost of a lost opportunity, or the exact benefit of the choices you are making on a daily basis.
Add opportunity cost analysis to your most important decisions
Ask yourself, which goals to prioritise? What costs you are actually willing to incur moving forward with a project or a career option? What is the regret you anticipate from not taking another choice? What are the explicit and implicit costs of your foregone choices? When the difference between your foregone option and the value of the chosen one is positive, it means that there is an alternative option with a higher potential than the choice you are making currently. When you find the difference is negative, there isn’t a higher value option.
Consider the value of your choices.
Since opportunity costs can be more difficult to calculate when numbers aren’t involved, you can however do so by calculating the value at the moment or for a future opportunity. For instance, when you are called in for an extra hour of work at your work place, your choices differ depending on what you want to value. If you consider the value at the moment and choose to spend it on what you want the most, you might choose to say ‘no’ and forego an extra hour’s pay. And when you choose to consider the future value of your opportunity, you might opt to work that extra hour to invest your earnings for the future.
Weigh your options.
Opportunity cost is equal to what you are sacrificing over what you are gaining, weighing your options helps you figure what you are getting out of sacrificing one outcome. It is not always enough to consider what you tend to gain from one over the other, but you also need to take into account what you lose. To gain a better perspective, ask yourself, what are my future scenarios of I opt for one path over another? What outcomes may they lead to and how is that going to change my opportunity cost? Gain awareness of your reasons for choosing one specific option and not choosing the other.
Consider your trade-offs.
Almost all major life decisions involve major trade-offs. The thing is that we do not happen to see the hidden trade-offs we are making in most of our decisions. Some only show up in the long-term. Being aware of your trade-offs is one way to change the way you make decisions. When you actively choose which trade-offs you want to make, you will be more better off in prioritising what you value the most. This way, you can see the difference between the trade offs you are making and the ones you’d rather go for.
How often do you evaluate the opportunity costs of your important decisions
What does opportunity cost mean for you and How do you measure opportunity cost of your major work goals?
How often do you see the benefit of choices you forego while making lifestyle choices?
Do you weigh explicit and implicit costs of decisions pertaining to your professional goals?
How often do you take your trade-offs into account?
Opportunity cost and trade-offs are important concepts that can be used in making decisions pertaining to many work and life situations. Most of the decisions we make each day may feel like the products of well-informed decision-making, but most often we give into habitual or behavioural choices without considering the price you pay for making these choices.
Overtime the choices we make, be it in the area of personal or professional advancement often add up and have enormous impact on our overall well-being. On the contrary, When you are aware of your trade-offs, and consider their opportunity costs, you are more tolerant towards risks you can take in order to reach your goals. You end up making more wise and well-informed decisions.
How to make well-informed
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