Opportunity Cost Calculator

The value of the thing you did not do

Every choice closes a door. You spent the afternoon on one thing, so you did not spend it on another. You bought the car, so the money is not in the fund.

Economists have a phrase for what is behind the closed door. The Federal Reserve Bank of St. Louis puts it about as plainly as it can be put: opportunity cost is the value of the next best alternative when a decision is made, it is what is given up.

Note the words next best. Not the total of everything else you could have done, which would be an infinite and useless number. Just the one thing you would have picked instead.

The concept splits into two halves, and the split matters for what this calculator can and cannot reach.

Explicit costs are the visible financial trade-offs at the moment of deciding. Money that moved, alternatives you can measure.

Implicit costs are the ones that never show up as a payment. Time, attention, the income you did not earn because you were doing something else, the flexibility you gave away.

This tool measures the explicit half, and it measures one particular version of it, which the next section is about.

What this particular version asks

The question here is narrow and useful: you are about to spend an amount of money. What would that amount have become if you had saved it instead?

Five inputs.

Two things about how it works that are worth knowing before you read an answer.

The return compounds monthly. An annual rate of 3 percent is applied as a twelfth of that, twelve times a year. This gives a slightly larger figure than annual compounding would, and it matches how most savings products actually behave.

Tax is charged on the gain only. Which is correct, and worth saying because it is the sort of thing calculators get wrong. Your original money is not taxed again. Only what it earned.

There is one constraint to be aware of. If you enter an inflation rate higher than the return, the tool stops and tells you the return cannot be lower than inflation. So the comparison it will run is always one where saving at least keeps pace with prices.

A four thousand dollar holiday, according to the Federal Reserve

The St. Louis Fed uses a worked example in its economic education material that happens to be exactly what this calculator computes, which makes it a useful thing to check ourselves against.

A four thousand dollar trip, or the same four thousand invested at 3 percent for ten years. The Fed puts the second figure at $5,397.

Run it here with tax and inflation set to zero, and the total comes to $5,397.41.

Which is worth a moment, because the agreement is not automatic. Four thousand at 3 percent compounded annually for ten years is $5,375.67. It only reaches $5,397 if the compounding is monthly, which is what this tool does and evidently what the Fed did too.

So the holiday did not cost four thousand. In the sense that matters, it cost $5,397, because that is what the same money would have been ten years later.

The Fed makes the same point at a much smaller scale, and the small one is arguably more unsettling. Fifty four dollars a month spent on coffee, rather than saved at 3 percent, leaves you around $7,619 poorer after ten years. Nobody experiences a coffee as a financial decision. Six hundred and forty eight coffees, compounded, is one.

That is the whole use of this tool. It converts a price tag into a future figure, and the future figure is the honest one.

Five lakh, ten years, and the two output rows

Something costing ₹5,00,000. The alternative is saving at 8 percent for 10 years, with 12 percent tax on the gain and 5 percent inflation.

Step by step, which is how the tool builds it:

So five lakh spent today forgoes about ten lakh thirty seven thousand in ten years' time, after tax. The purchase costs roughly twice its price tag once you count what the money would otherwise have become.

The second row exists because ten lakh in a decade is not ten lakh today. Adjusting for inflation puts the figure back into money you can feel, and on these inputs that is about ₹6,20,676 in today's terms.

That second number is the one worth arguing with yourself about. Not a distant seven figure sum, but this: the thing you are buying for five lakh is competing against about six lakh twenty of present day purchasing power. Is it worth that?

Sometimes obviously yes. Which is the point of putting the question in comparable units rather than pretending the answer is always no.

How the second row handles inflation

Worth being specific about the method, since inflation adjustments have more than one convention and the choice moves the answer.

This tool multiplies the total by (1 - inflation) raised to the number of years. So five percent inflation over ten years applies a factor of 0.95 to the tenth power, which is 0.5987.

The more common approach in finance divides instead, by (1 + inflation) raised to the same power, which gives 0.6139. That is the same discounting logic used by our present value calculator and everything else in the discounting family.

On the worked example the two land at ₹6,20,676 and ₹6,36,408, a difference of about 2.5 percent over ten years. Small at short horizons, wider as the period lengthens, and the subtraction method always gives the lower figure.

Neither is meaningless. Multiplying by (1 - i) each year describes purchasing power falling by a fixed proportion of what remains. Dividing by (1 + i) describes prices rising by a fixed proportion, which is what inflation figures actually report. If you want the second version, take the total savings figure from the first output row and run it through the present value calculator with your inflation rate as the discount rate.

And if you want the after inflation growth rate rather than an amount, our real rate of return calculator does that in one step.

This is not an argument for never spending anything

A calculator that turns every purchase into a large forgone sum can be read as a lecture, and it should not be.

Opportunity cost runs in both directions. Money saved is also money not spent on something with real value, and the tool has no way of knowing what that something was worth to you. A holiday with people who will not always be there, a course that changes what you can earn, a repair postponed until it becomes a replacement. All of those have returns, and none of them are in the second box.

The Fed's own framing is about not being shortsighted, which cuts both ways. Spending without noticing what it costs is one kind of shortsighted. Saving reflexively while the years pass is another.

Three things worth checking before letting a large forgone figure decide anything.

Is the return realistic? The figure assumes you actually invest the money and leave it there for the whole period. Money not spent frequently gets spent later on something else, and then the opportunity cost was hypothetical all along.

Is the alternative comparable in risk? A high assumed return usually carries a chance of loss that the arithmetic does not show. Comparing a certain purchase against an uncertain return is not quite a fair fight.

Does the purchase have a return of its own? Equipment that earns money, a qualification, a repair that prevents a larger bill. Those belong on the other side of the ledger and this tool will not put them there.

The costs that never reach a calculator

The explicit half is the half with numbers. The implicit half is often larger, and the Fed's material is specific that these are the ones people miss.

Time. The most common and least counted. An hour spent on something is an hour not spent earning, learning or resting, and the value of that hour changes depending on which it was.

Foregone income. Studying full time costs the fees and also the salary not earned meanwhile. Running your own business costs the wage you would have drawn elsewhere. Neither appears in any accounts, and economists call these implicit costs precisely because no payment is made.

Assets you already own. A shop trading from a building the owner owns pays no rent, and is still bearing the rent it could have collected. This is why accounting profit and economic profit differ: the first counts only money that moved, the second counts what the resources could have earned elsewhere. Our residual income calculator applies exactly this idea to a company's equity capital, charging it for capital that its income statement treats as free.

Optionality. Money committed is money not available for whatever turns up next. Locking capital into an illiquid thing has a cost even when the return is good.

None of these can be typed into five boxes. Knowing they exist is most of the benefit, and it is the reason the discipline is worth more than the arithmetic.

Hope this makes a spending decision a bit easier to see clearly, in either direction. If a figure here does not match what you have worked out, do tell us, because we would rather correct it than have you deciding on a wrong number.

Questions people ask

What is opportunity cost in one sentence?

The value of the next best alternative you gave up when you chose something else. Not everything else, just the one thing you would otherwise have picked.

What return should I assume?

Something you would genuinely have earned at a risk level you would genuinely have accepted. A fixed deposit rate is a conservative and honest choice. A high equity return assumes a risk the arithmetic does not show.

Is tax applied to the whole amount?

No, only to the gain, which is correct. Your original money is not taxed again.

Why are there two output rows?

The first is what you would have in the future in nominal terms after tax. The second restates it in today's purchasing power, which is the figure most people find easier to weigh a purchase against.

Why does it refuse when inflation is above the return?

The tool requires the return to be at least the inflation rate. If you want to model saving at a rate below inflation, work out the total with inflation set to zero and adjust it yourself.

Does the return compound monthly or annually?

Monthly. An annual rate is divided by twelve and applied twelve times a year, which gives a slightly higher figure than annual compounding and matches how most savings products work.

Can I compare two specific options rather than spending against saving?

Not directly, since the tool compares a purchase against saving at a rate. For two investments with different cash flow patterns, our discounted cash flow calculator and profitability index calculator are built for that comparison.

Does this include the value of my time?

No. Time, foregone income and flexibility are implicit costs, and they are frequently larger than the financial figure. They have to be weighed rather than calculated.

References

A note on the sources. The definition used at the top of this page and the worked example in the middle both come from the Federal Reserve Bank of St. Louis's economic education material, which is a central bank teaching resource rather than a commercial one. That example is also the reason the compounding note exists: the Fed's published figure of $5,397 for four thousand dollars at 3 percent over ten years only arises under monthly compounding, which is what this calculator uses, so the two agree to the cent. The distinction between explicit and implicit costs, and the observation that the implicit ones are the easily missed ones, is from the same source.

1. Federal Reserve Bank of St. Louis, Real-Life Examples of Opportunity Cost, Open Vault, on opportunity cost as the value of the next best alternative, on the distinction between explicit and implicit costs, and on assessing alternative uses for money rather than being shortsighted. https://www.stlouisfed.org/open-vault/2020/january/real-life-examples-opportunity-cost
2. Caceres-Santamaria, A., Money and Missed Opportunities, Page One Economics, Federal Reserve Bank of St. Louis, October 2019, the source of the worked examples on forgone savings from discretionary spending. https://www.stlouisfed.org/education/page-one-economics-classroom-edition
3. U.S. Securities and Exchange Commission, Office of Investor Education and Advocacy, Compound Interest, Investor.gov glossary, on interest earned on principal and on accumulated interest, which is the mechanism behind the growth figure. https://www.investor.gov/introduction-investing/investing-basics/glossary/compound-interest
4. U.S. Securities and Exchange Commission, Compound Interest Calculator, Investor.gov, which will reproduce the growth figure independently if given the same rate, period and compounding frequency. https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator