Analyzing opportunity cost to save or make money

Opportunity cost is the potential gain that you could achieve by doing one thing over another.

Let’s consider the following about a $50,000 automobile that you plan on purchasing:

• You have $50,000 in cash that you won’t need access to for at least 7 years
• You’re offered an automobile loan with an interest rate of 1%
• You have a savings account that pays 3% in annual interest

How would you choose to choose to handle the purchase of this automobile? Read below for the answer.

If you said that you would finance the automobile with an interest rate of 1% and keep the $50,000 cash in a 3% APY savings account, that would be the wise thing to do. It comes down to basic math. In the example provided, you don’t need access to the $50,000 for at least 7 years. You could give the dealership $50,000, but you would miss out on the interest that you’d receive on the 3% APY savings account. 

Weigh your options before acting

Before making purchases, major purchases in particular, it’s wise to sit down and weight all of your options and how much you’d earn or lose by doing each of them.